Two Different Markets

We have two different markets operating in the stock market presently. We have the New York Stock Exchange Index, which is the broadest index of all, telling us that this rally since August 9 has been incredibly weak, as shown by low volume and decreasing advance-decline ratios. On the other hand, we have the NASDAQ market that has taken out the August highs as of Friday’s close. The NASDAQ has been up 6% this week, which makes it the strongest week in over two years. The Dow Jones transports and the Russell index were incredibly weak and could not even attempt last week’s size. The Dow Jones Industrial Average and S&P 500 both were able to retrace to the 78% retracement of the highs of last week. This sets up a move to the downside that should start immediately this coming week. The market has gone nowhere since August 9. Should we take out the August 9 lows we will be looking at a very severe correction taking us down through the October or later December cycle lows. Bear market rallies are very fast and do not last very long. If we have a strong up week in stocks this week then this analysis would be highly suspect.
There was a comparable period in 2008 right after the Lehman Brothers bankruptcy when the market went sideways for 18 trading days. This is what has been occurring recently and whether it has the same downward characteristics as that move is well worth watching. Going below 1100 in the S&P 500 futures would be an indication that we are ready for another down move. This market continues to look bearish to us and is overbought on a short-term basis.
There is a new moon coming on September 27, which have usually been associated with highs, so if the market is making a high on September 27 it would most probably be a chance to get short for the coming week.

Treasury bonds

Treasury bonds continue to hover in the 140 area with a potential target taking it to 151. It’s hard to believe that 30 years ago these same bonds sold for 46 which made a $46,000 investment in $100,000 treasury bonds yielding 8% the best investment of the 1980s. For the past 30 years interest rates have been dropping. Credit cards are available to anyone that can sign his name or make an X. These debts are going to have to be repaid or massive defaults could arise. Destruction of the US dollar is also possible but it appears when push comes to shove the rest of the world sort of likes dollars when the rest of the world is being attacked financially. We are still waiting for an entry signal on the TBT which would get us short the treasury bonds. It will take some time for this pattern to unfold but we are watching it on a daily basis. If I had to pick a trade of the decade for the rest of the 2010-2020 period, this would be the one I’d choose.

Gold

The Gold Bug Index that we featured in last week’s letter has so far shown that the 98% bullish consensus was a little too high. Gold has since corrected over $120 an ounce and is in the process now of recovering a bit. Silver, on the other hand, still looks incredibly bearish and cannot get out of its own way. No matter how much gold rallies, silver does not follow along in the same percentage. The Gold Silver Index is also showing signs of a major top so at this point it is prudent to stay away from long positions in these markets. Even copper was able to rally with the stocks this week which is highly unusual as it has a better than 85% correlation to stocks
These markets look like they want to go lower and not higher.

Foreign exchange

The key to the foreign exchange market is to watch the euro/usd. All the financial press seems to think that the euro is going to hold up and maintain its positions of prominence across the European Community. There is also a small faction that think the euro will dissolve because of the different number of countries it is trying to represent with no common thread to prevent one country from cascading down its debt onto another country. They talk about Greece, Italy, Iceland, and Portugal, but there are other countries that are also wavering on the brink. The world is awash in debt. This debt is what is dragging us down. Not only on a country by country basis but on a global basis. No one is immune from China to the US and Norway to Argentina. We’ve all been borrowing too much money for too long a time and we are going to pay debts eventually. The real sleeper in the currency market in my opinion is to go short the Japanese yen versus the US dollar. The pattern is very similar to what happened with the Swiss Franc / US Dollar when the Swiss dropped the value by 10% overnight making Swiss deposits 10% less for those that just put their money into their bank for safekeeping. Foreign exchange trading is not for the faint of heart and when governments do these types of things it causes havoc, but usually for a short-term basis and then we go back to our daily lives. The US dollar has continued to hold and has rallied strongly from the 73 level. Watch the euro because if the euro drops below 134 it is going to signal that there is much more to go to the downside. This past week the euro rallied over 300 pips but that was coming after a 10 day down move that saw more than 1000 pips evaporate from that currency.

Crude oil

Strong resistance still remains in crude oil at the $90 per barrel level. The 61% level on the daily chart has turned back prices six times in the past several weeks. It will take a strong move above $90 per barrel to get this market moving on the bullish side. I see no reason to be extremely bearish or bullish on crude oil as it seems to be in a trading range between $90 on the upside and $75 on the downside, which happened to be the culmination of the final pattern of the AB=CD pattern.

Technical corner

In my office I have a 4×4 oil painting done by a very famous artist from California who passed away many years ago. Her husband used to come into my office and see all of my little handwritten notes on note pads on my rules and patterns. For Christmas in 1976 I got this lovely oil painting that I treasure most dearly. At the top of the painting is a statement that says “he who knows not what he risks — risks all”.

The following are the 10 Commandments of trading that I try to follow religiously-

1 – never add to a losing position
2 – when in doubt, get out and stay out
3 – plan your trading and stick to it
4 – take equity out for rainy days and those less fortunate
5 – never close a trade without a reason
6 – stops are placed to protect you — make sure you use them
7 – the only true facts in commodity trading are fear and greed
8 – never allow a substantial profit to turn into a loss
9 – distribute your risk equally over several markets
10 – never hedge a losing position

Trade of the week

Last week we suggested that possibly taking a short position in the gold bug index was the right thing to do for highly speculative accounts and so far that has worked. This week the trade of the week is going to be patience – holding no position but waiting to enter the short treasury bond trade. We will live through this one together folks as I think it could be one that will be able to tell our grandchildren about, hopefully, if they’re still speaking to us. The chart pattern is certainly there but the entry pattern is not. We need a correction and then a quick retest to enter the market. I watch this one each day religiously and when we see it we will be ready.

Final thoughts

This week a very famous hedge fund manager, Bill Ackerman, came out and said that the best trading seen in years was to go long the Hong Kong dollar against the US dollar. Currently the Hong Kong dollar is pegged at $7.75 to the US dollar. He feels that the market is going to go to a level where the Hong Kong dollar will appreciate to the US dollar. Keep in mind that China took over Hong Kong in 1997 from the United Kingdom. Nothing really changed politically or financially during that time and Hong Kong has now become the Switzerland of the Far East. Make no mistake about it, the Chinese have a lot of power there and at any time they could do something to upset the apple cart. However, this is a very unlikely event. What is interesting about Mr. Ackerman’s comments is the fact that he was so adamant about it and is willing to share with everyone why he was doing it and what a great trade it was. This reminds me of some comments made by one of the greatest traders ever, Amos Barr Hostetter, who single-handedly trained many of the market wizards and great traders during his tenure at Commodities Corp. which he started in the early 60s. Amos said keep your own counsel. Do not tell everyone what you are doing or why because then you become attached to the outcome and that is a very dangerous situation. Lose your opinion instead of your money which is a famous quote from Paul Tudor Jones.

There are two futures markets that are making similar patterns this week; the precious metals market and the crude oil complex. We will first take a look at the precious metals market. The gold and silver index, XAU, is forming various Gartley patterns. It goes hand-in-hand with the various Gartley patterns that we have forming in gold, silver, platinum and copper. I know that copper is not a precious metal but it usually tags along with the others most of the time. Gold has formed a perfect Gartley sell pattern at $1775 per ounce. An AB=CD pattern is present in all of these metals. Probability strongly suggests that we are in an area where a correction should occur. Dealing in probabilities is the nature of our business so if these patterns fail it would strongly suggest much higher moves and potentially into new high ground. Silver has been lagging gold since it made its high on April 25th. Platinum likewise is tagging along and now selling at more than $100 per ounce discount where in the past it has always sold at a premium to gold.

Crude oil has come up against strong resistance i.e. we think at the $95 per barrel level. This level is shown to be strong resistance over the past several weeks. It will take a strong close above the $96 per level to get this market moving to the upside. Keep in mind it has been going up for several weeks and is in a very overbought condition. Gasoline futures have lagged badly to the crude oil market but were able to rally $.13 a gallon this past week. The same situation is occurring in heating oil which also rallied the same amount toward the end of the week. It might’ve been related to the bad weather coming to the eastern United States but it could be something more bullish. Crude oil is the one to watch and is the most actively traded around the world. This market moves in incredible swings and makes beautiful patterns following the Fibonacci sequence of ratios in nearly clockwise precision.

In the stock indices, the only thing we can say starting this week is that the market did not explode to the upside following the myriad of Fibonacci numbers and patterns that we have forming on October 27th. I would make a strong suggestion at this time! Draw a circle around the highs that were made on October 27th in all the stock indices. Should we close above these highs it would tell us that the cycle we were looking at has failed and one more leg is coming. Bearishness around the world has dissipated a bit and the news coming out of Greece seems to control just about everything. Frankly, in my opinion it means very little and the markets are going to go where they decided to go from the very beginning. Remember in last week’s letter we talked about the importance of all those patterns and ratios that came together on October 27th. Should the Dow Jones go above 12,300 and the S&P 500 above 1270 it would appear that something is wrong with this BEARISH cycle. It’s apparent that we are in a downtrend on a global basis. What we have seen since October 4th is a sharp short covering rally in my opinion. Weakness this week would confirm that this was the case but strength, as mentioned before, would certainly dampen my bearish enthusiasm. None of the indices that we discussed last week were able to make new highs. All that happened on Thursday and Friday were Fibonacci retracement’s in nearly all of these markets. In my opinion, it boils down to what happens this week. Weakness this week tells us that we are going lower and the more weakness the lower we go! The NASDAQ has continued to lead the market and I’ll be watching very closely because the stocks are now the social network much like we had with the Internet bubble in 2000.

Treasury Bonds

Last week we expected a sharp rally in the Treasury bond market because it bounced off the 382 retracement of the year’s lows. T-bond’s stopped exactly at the 618 Fibonacci retracement and it sold off marginally. The price we are watching on the downside is roughly 138. Should the market extend above 147 to form the final target that were looking at 151 I am going to issue a special report getting ready for a short sale. I still believe that this will be the trade of the decade by being short bonds but I’m still waiting for that last gasp making interest rates on a 30 year treasury bond below 2%. Ask anyone you know who they would lend money at 2% for 30 years?

Foreign Currencies

Last week’s foreign exchange markets were very active. The euro hit the exact 618 of the weekly charts at 142.50 as the British pound was making its 61% retracement above the 161 level. The big news this week was the intervention by the Bank of Japan much like what they did in August. The butterfly pattern that we have been looking at with the longer-term cycle of 45 weeks and the shorter term cycle of 24 days fit perfectly with that intervention. What was interesting to watch was that the amount of pips that the Japanese yen vs. U.S. dollar moved in the first few hours of trading. It was one of the most unbelievable things I’ve seen as a technical analyst. The move in August was exactly the same as the move we made last week. This was to the exact pip. Anyone who does not believe that central banks can play havoc with Forex markets can only take a look at this chart and see that they do have some type of preconceived plan at certain times. Should the Japanese yen/US dollar get above last week’s high it will tell us that the yen is going to weaken versus the dollar which we have been saying for quite some time.

Trade of the Week

Gold is making a perfect Gartley sell signal at the $1775 per ounce level! Aggressive traders could use this as a shorting opportunity using a $15 per ounce stop. First profit objective would be $45 per ounce and the second profit objective would be $90 per ounce. This is not a trade for the faint of heart but only for experienced commodity traders. Using the ETF GLD it would be a similar pattern forming. What makes this so interesting is that we have the same Gartley sell patterns in all of the metals.

Technical Corner

This week’s focus will be on live cattle:
The live cattle market is forming another AB=CD pattern following the same pattern for the past few months. The importance of the last AB=CD pattern into new high ground is very important as it means a breakout has occurred or a bear trap has been set (notice the areas on the chart as the cattle began their “bull” run). Harmonic moves like these are on all charts and I highly recommend technicians look at them as they are telling a story of cycles in price! COW, the ETF for cattle, has lagged badly recently which may be another clue as to a potential top in cattle. It is my opinion that this emphasizes why some ETF’s are not a good proxy for the actual futures account but can still be used for exposure in retirement accounts that allow these types of investments.

Final Thoughts

The big news this weekend came from the Chicago Mercantile Exchange regarding the deposition of funds from the bankruptcy of MF Global. It appears that an agreement has been reached to return the funds but there are still many questions to be answered. Originally, on Friday evening the Mercantile Exchange, members had a meeting and issued a very vague statement. The statement contained words that appeared to mean that all margins were going to be raised. Later this was refuted and basically they are trying to make equitable arrangements to transfer accounts from MF Global to roughly 10 other CME firms. What they are going to do has never happened before so how it is going to work is anybody’s guess. The one thing that I do know is that the Chicago Mercantile Exchange values its integrity more than anything else. Keep in mind that if you have your funds in exchange traded brokerage house and that stock begins to drop rapidly I would highly recommend having a bank wire to close your account as quickly as possible. Evidently MF Global sent out checks to people wanting their money as opposed to a bank wire and now these checks are supposedly worthless because of the bankruptcy, which would make sense. The only advice I can give you here folks is to follow the money as that’s where the end is going to come.

The markets around the world go round and round by Larry Pesavento

Stock markets

As we described last week, we expected stock markets around the world to react bullishly over these past few days due to the patterns that they had completed on the downside. Another reason for the bullishness was that some of the more famous names in economics such as Volker, Bernanke, Stieglitz and Bill Gross have all called for the beginning of a full blown depression. Public figures often become maligned when they make a bad call (or two). Over the past few months, Bill Gross has been given a “literal” beating in the press due to the poor performance of his Pimco bond fund, which ranks near the bottom of this category of funds. This is also true of John Paulson whose hedge fund has taken some very bad hits recently. Of course, all of this does not detract from the successful track record of these gentlemen, but rather reflect how the financial press operates.

The low we made on October 4th, which coincided with the completion of many patterns in both domestic and international indices, is an important point in the current market. While we remain very bearish over the longer term, I believe that we may still see a rally in the S&P 500 back towards the 0.618 or 0.786 levels. The performance of the S&P this week was the strongest in several years as it rallied nearly 6% during this period. Although the banking index and foreign

Markets continue to look weak, they too have rallied to a considerable extent. In contrast, the Nasdaq has already reached this level and several of the stocks in the technology sector are making dramatic vertical moves (i.e. AMZN and AAPL). Note however, that the Nasdaq is a very biased indicator as it tracks only 100 stocks in a cap-weighted manner, so that expensive stocks are equally weighted as cheaper stocks.

This week I have also featured the Bradley model that is useful in giving us a rough idea of how stocks should perform over a shorter term interval (i.e. 6-10 weeks). The charts I have included show both the shorter cycle (going back several months), as well as for the whole year, showing a broader approach to cycle theory over the long term. While the Bradley model is accurate nearly 70% of the time, it should also be used in conjunction with Fibonacci patterns and over bought/sold indicators to provide the most reliable results.

Treasury Bonds

Treasury bonds have completed their first bullish AB=CD pattern at the 138 level. As H.G. Gartley once said, one should buy all AB=CD patterns whenever they appear in a bull market. Even as we keep in mind that over the long term, this market is making a top of biblical proportions and could easily come down very hard, there is still the opportunity to go long bonds at this point with limited risk. As illustrated in the chart, the risk for the proposed trade would be approximately 1 point with a potential profit of at least 2 points.

Precious Metals

Copper was the feature member of the group this past week as it held the 3 dollar per pound level and rallied 40 cents in step with the overall stock market. As long as copper manages to hold this level, it has a fair chance of making a Fibonacci retracement towards the 3.75 per pound area. However, we still believe that the $3 per pound level will be broken to the downside over the long term.

Gold continues to move in a sideway motion between $1,590 and $1,690 per ounce. There should be strong resistance at the 1,770 level on the upside and reasonable support around 1,590. As with copper, we also believe that long term gold prices are likely to head lower. This downward trend is particularly true for silver as it underperforms gold, copper, and even platinum and has essentially become the ugly sister among the metals.

Foreign Currencies

The big winners in foreign exchange this week were Euro and British pound, both of which completed perfect Gartley patterns as illustrated in last week’s letter. We should now expect some resistance for the Euro at the 140-141 level. Over the long term, it looks as though the Euro could be headed much lower. As for the pound, it has now completed at 75-week cycle at the exact Fibonacci Gartley buy pattern and could rally to the 161-162 level before moving lower.

The US dollar index has now completed another rally that was equal to the major move several months ago and now appears to be retesting the 0.618 or 0.786 levels to see if it will hold. Should the dollar index break below 73, it would be an extremely bearish sign for the dollar over the long term.

Crude Oil

Gasoline futures have now rallied over 40 cents per gallon off of the Gartley pattern that it completed several weeks ago at $2.46 per gallon. It now looks ready for some type of correction particularly since the pattern it completed was a perfect Gartley which also incorporated a “3-drive to the bottom” pattern.

Crude oil itself formed a bottom at the 0.786 level at 75 dollars per barrel, which was also a double test of the 0.786 retracement off of the lows from last May. As long crude remains above 75, there is a good chance it could work higher.

Trade of the Week

This week, we see an opportunity for profit in buying January 180 puts on IBM. Earnings for IBM are due to come out on Monday just as the stock is completing both a “3-drive to the top” pattern as well as a bearish butterfly pattern. In our opinion, these combinations of patterns make this a very low risk trade. Using a put option here provides us with the flexibility of maintaining unlimited profit potential with limited and well defined risk, which at this time is the price of the put (around $5).

Technical Corner

One of the most common errors people commit in trading is to over-trade. Any time you find yourself trading in the realm of more than 10 times per day, you are likely to be over-trading. The danger with this type of situation is that it is very difficult to focus on so many things at one time. Although some of the younger folks can focus simultaneously on multiple online games, this is very different when substantial amounts of real money are involved. A second common mistake is placing stops that are too close and failing to prepare where entry levels should be. As a result, mistakes start piling up, which then lead to one after another. By preventing these avoidable initial mistakes, one can follow the adage: take care of the first mistake and the second will take care of itself.

Final Thoughts

After looking at all the charts this weekend, the big question I now have on my mind is how much the markets can/will rally before we start towards the downside again in earnest. Although the next big cycle does not come until October 26, keep in mind that once markets start gaining momentum they can move very quickly. This was very evident in the S&P 500’s 6% move this past week.

I am also watching to see how the bond market responds to the bullishness in the stock market. From a long term perspective, bonds are looking like the best short since tulip bulbs in 1670, but that is my opinion and has been yet to be verified by actual profits. Nevertheless, I continue to wait for an entry in the bond market either via an ultrashort ETF (e.g. TBT) or Treasuries themselves. The outstanding target of 150 is still possible for Treasury bonds, but this is likely to occur only if there is some very bad news coming out from Europe.