Two Downside Scenarios for Precious Metal Stocks
Monday, March 9, 2009
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report
When I last wrote to you two weeks ago, the Dow Jones Industrial Average (^DJI) and Dow Jones Transportation Index (^DJT) were the only two indexes that had traded below their November 2008 lows.
Since then, all the indexes I follow - including the smaller-cap ones, Wilshire 5000 and NYSE Composite - have followed suit. The only pocket of resilience against this trend is the Nasdaq 100.
Here’s why this trend is important - and what it signals in the days and weeks ahead. Brace yourself…
Set For More Selling, As Major Indexes Slide To New Lows
Based on the pattern recognition component of my 1-2-3 Trader service, when an index makes a new low, the system then projects a minimum downside target. The index proceeds to reach or exceed this target more than 80% of the time.
The good news is that as of last Friday, the Dow Industrials and Dow Transports had already reached their minimum targets, while the S&P 500 was within just six points of doing the same.
However, the Nasdaq Composite and smaller-cap indexes are still anywhere from 4% to 8% above their minimum targets and based on the current daily chart patterns, more selling is probably in the cards.
As for when these indexes could hit these downside targets, keep in mind that the chart patterns are longer-term (based on data going back to last summer), so it could be a matter of several days or several weeks.
On the other hand, if the stock indexes rally before their targets are reached, there’s about a 35% chance that they could generate an alternative downside target that wouldn’t be as low as the original projection.
So since the Nasdaq 100 is currently bucking the trend and hasn’t yet traded below its November lows, let’s take a closer look before we get to this week’s selected sector…
Can The Nasdaq Hold Up? These Numbers Will Tell You…
Below is a daily chart of the Nasdaq 100. As you can see, the November low was 1,018 and if there is price acceptance below that level, the minimum downside target would then come in around 918-point area.
It’s a long shot that the Nasdaq 100 won’t eventually follow the other indexes to new lows, but if its fellow indexes reach their main or alternative downside targets, and the Nasdaq 100 stays above 1,018, it will set up all the indexes for a major reversal.
Now onto this week’s specific sector…
A Surprising Member Of The Bear Camp
In a climate like this, it’s no surprise to see that most of the main stock market sectors look bearish.
Surprisingly, though, one of them includes the Philadelphia Gold & Silver Index (^XAU). This index is comprised of a number of gold and silver stocks and generally moves up and down along with the underlying metals.
Over the past month or so, metal prices have moved up and down in an inverse relationship with the U.S. dollar - which is typically how this relationship works. However, that seems to have changed a bit, with gold and silver now moving in an inverse relationship with the main stock indexes.
And interestingly, even though gold recently traded above $1,000 an ounce (a level it last reached in July 2008), ^XAU has lagged badly.
So what’s the deal here?
Two Scenarios For The Gold And Silver Index
When gold prices breached the $1,000 mark last July, ^XAU responded by rising to 206 points.
But as you can see, it’s currently trading well below that level - about 41% lower, in fact. Not only that, the index has failed to climb above its 200-day moving average - even with gold’s recent surge.
Over the past couple of weeks, it’s also broken below its uptrend line, which comes in at the same area as the 200-day moving average - around 132.25 which is solid resistance.
Whether we see a market rally, or a continuation of the selloff, here’s how to play the next move…
If The Market Rallies: In this scenario, we could see investors dump commodity stocks in order to free up some cash to buy other market sectors. This would result in the metals and ^XAU moving lower.
If The Market Selloff Continues: If we see the status quo and the markets continue to decline, rather than buying more “safe haven” investments like gold and silver, we may see investors selling their metals stocks in order to meet margin calls.
Barring a precipitous drop for the dollar (which would likely cause investors to rush back towards the metals), unless ^XAU can close above 132.25 a couple of times, gold and silver stocks may continue to work lower. As far as metals are concerned, they’re looking a little overbought and the short-term caution flag is out.
That’s all for this week,
Jim
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One Response to “Two Downside Scenarios for Precious Metal Stocks”
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From a tech standpoint, running the trendline on the June Contract CBOT gold chart, the price is just touching the lower line; has not broken through. MACD is in accelerating decline, and the RSI is at the same level as when gold was 800 early in this year. Downside looks highly dominant.