XAU Gold/Silver Stock Index May Be Ready To Breakout

The gold and silver mining stocks have lagged the precious metals badly during the latest advance with only a few exceptions.  That may be getting ready to change.  Given its poor relative strength performance, the recent failure of the XAU at its 2008 high prompted some observers to speculate that the index was about go into a serious decline.  However, after 3 weeks of rallying in what appears to be a 5 wave advance, the XAU has recovered its 2008 high.  Depending on how you count it this could be either the third or fourth attempt to breakout.  I would call it the fourth attempt as shown below.

As many have observed in the past, including WD Gann, when a market fails to breakout on the first, second, or third try it can be a good shorting opportunity.  However, a successful fourth attempt is a buy signal.  I suspect the XAU will rest here for 1 to 3 weeks in preparation for an advance that will make up for lost time.  This may be a good opportunity to take positions in leading gold and silver stocks.  Two candidates that I am looking at are IAG and SLW.

The Qs did in fact breakout from the triangle yesterday and slightly exceeded the calculated targets.  It just seems to me that this market is running on borrowed time with respect to a needed correction.  A four week pullback to the 2010 highs might be a good long entry for the next advance as long as it occurs as a corrective pattern.

Another Sign Of A Top?

Amid record bullishness among professionals (http://www.marketwatch.com/story/fund-managers-bullishness-at-a-record-survey-2011-02-15) we have another sign of an impending top as the Qs have formed a very nice symmetrical triangle on the intraday chart.  Usual time and price relationships suggest a top around noon today with target of 58.81+/-, although all that is required is an attempt at a new high around 58.66.

I would caution you not to be fooled by all of the great action in leading stocks of late.  This says something about future market potential this year, but nothing about the immediate future.  I have seen this all too many times before as a plethora of individual stock names appear to heading to the moon just as the broader markets top.  Then all of the wonderful patterns and price projections go to hell in a handbasket.  It is so tempting to be buying these breakouts, but all of the gains for this year could be given back in just a few days.  Maybe this time will be different, but I doubt it.  As they say, that's my story and I'm sticking to it.

5 Waves Up In The GDX

Waiting For Confirmation

We are waiting for a close below 1311.74 to confirm that a top is indeed in place.  It is premature to call a top, but even if yesterday's high isn't the top, I think it would take only one more retest of the high to finish it off.  We have a completed wave count, very low volume and bullish complacency.  All the ingredients of an impending change in the trend.

For those who may not go back and look at previous posts for comments, there was a question about the results  in my post from January 1 - A Look At The IBD 100. I used a hyphen between the numeral and results which some may have interpreted as a minus sign.  All of the results were actually positive. However, the point of the post was that using the IBD 100 seriously underperformed using the top 10 relative strength stocks of the Russell 3000.  Regardless of your trading strategy, one should not blindly accept a list of "top" stocks.

Bottom In The TLT

Turns in the TLT have preceded turns in the stock market by a few days since the rally began in 2009 with a negative correlation.  We now have a setup for a bottom in the TLT with a completed thrust out of a descending bearish triangle, falling volume from the momentum low that occurred in November and rising momentum.  If past is prologue then a top in the stock market should be imminent if not coincident.  To confirm the turn we need to see the TLT close above the 12/15 low of 90.47.  Since we have a completed pattern, or at worst one more new high to complete a pattern, in the stock market, coupled with a possible bottom in the Dollar and the TLT, it is time for top in stocks.

In reviewing the commentary on various blogs, trading websites and the financial news media, the outlook for stocks crosses a spectrum from the extreme bear case to the extreme bull case.  The extreme bear case is well known and is a call for stocks to top now and begin a steep decline to multi-decade lows.  The extreme bull case is that we are cycle wave 5 up to new all time highs and currently we are in the early stages of primary wave 3 up in cycle wave 5.

The problem with both of these extremes is that they disregard a number of facts that contradict them.  With respect to the bull case, it is fairly clear from past history that secular bear markets have lasted at least 12 years if not 16 to 18 years.  If we are cycle wave 5 up, then this last secular bear market from 2000 to 2009 would be the shortest in history.  For the bear case, there are two problems.  First, we have exceeded retracement levels both in price and time that would have been expected for primary wave 2 up.  While 2nd waves can theoretically retrace up to 99% of the previous 1st wave, it really doesn't seem consistent with the fundamental arguments for primary wave 3 down for this to occur.  Secondly, longer term cycles point to the rally continuing well into 2012 or 2013, further reducing the likelihood that this is a 2nd wave.

Readers of this blog know that I have been calling this rally an x wave since 2009 with an expectation that we could retest or exceed the 2007 stock market highs.  Unfortunately, I have underappreciated the potential for this rally to continue without the typical retracements.  I fully expected that we would see a deeper and longer wave [B] or (B) from the April 2010 high.  The continuation of the rally in 2011 has eliminated the likelihood, though it is still possible, that the current rally is wave (B) or B of an expanded flat or running triangle.

I would caution you to be careful and not draw dangerous conclusions.  There are several possible outcomes still on the table.  The most bullish is that we are completing wave (1) of [C] up.  I don't like this option because of the "wedgy" character of the rally, but it is possible.  Thus, we could see a 38% to 62% retracement of the rally from 7/1/10 in wave (2) down with a 50% decline taking the Qs back to the April 2010 high.  We could also see an (X) or [X] wave of undetermined length as wave x morphs into a double zigzag.  There are others, but these two seem the most likely.  The difficulty is that an (X) wave often doesn't have any clear relation in time to the preceding waves.  It is more like a knot that binds the two parts of the larger correction together.  Wave (X) could last 4 weeks or all of 2011.

Regardless which outcome prevails, the time for heroic shorting is long past.  The action in leading stocks suggests that this rally will continue after a correction and money is to be made primarily from the long side.  That is not to say that shorting is out of the question, but it should be done from the view of a hit and run trade, not a trend trade.

Performing well in the current market environment has been and will be difficult for most traders, but we cannot ignore the larger trend.  For those who have missed out on the recent rally there is no reason for regret.  That will happen from time to time.  This cyclical bull market could continue for another 2 years.  This latest rally has only lasted 7 months, so no worries.  Trading is for a lifetime, not just a few months.

Conditions For A Top Satisfied

At this point all of the conditions for a top have been satisfied.  The upper trendlines of the wedge patterns have been overthrown.  The last movement from the 1/28 low has completed in 5 waves.  Today is a possible cycle turn date according to several different methods of calculation.  All that is needed is for a decline to begin.  A close below yesterday's low of 1311.74 would be the first indication that a correction is underway followed by confirmation with a close below the 1/28 low of 1275.10.  For the Qs the levels are 57.49 and 55.39, respectively.

Volume today has been on the light side, another indication of a lack of conviction.  In addition, we have not seen a serious decline since August, a period of almost 7 months, which is quite atypical.  The bottom line is that given all of the necessary conditions for a top have been met, if the market continues to rise, we have to conclude that something completely different is going on.  A correction will occur at some point, but the higher the level from which it occurs, the less likely serious damage will be done as the longer term 50 day and 200 day EMAs will approach and move above the 2010 highs, solidifying support at those levels.

Approaching A Top

It appears that the long awaited for top is near at hand as a (likely) small degree 5th wave is in progress.  This should complete the rally from the July 1 low.  There have been quite a few close calls (apparent tops that weren't) along the way, but the current pattern has all of the characteristics of a final impulse to a top.  It looks like the SP500 will double its 2009 low before it rolls over.

In order to confirm a top, we will have see a break of the January 31 low coupled with a 5 wave decline.  Until then any top will just be a pullback in a still ongoing uptrend.  The level of complacency has reached such an extreme that it is hard to fathom how a correction would not occur soon.  However, this market has fooled just about everyone - even the bulls who have called for minor pullbacks - so who knows if the craziness will continue.