How to Play the Next Leg Up in Gold

The stock market followed through on
Tuesday’s bullish reversal by posting a round of solid gains on higher volume
yesterday. Both the S&P 500 and Nasdaq Composite rallied 0.7%, while
the Dow Jones Industrial Average gained 0.8%. Small caps perked up, enabling the
Russell 2000 Index to advance 1.2%. The S&P Midcap 400 was 0.9% higher. Each of
the major indices finished near their intraday highs, though the Nasdaq
Composite displayed relative weakness in its intraday chart pattern. The S&P and
Dow closed firmly above their respective morning highs, but the Nasdaq barely
exceeded resistance of its morning high. Bearish divergence in the Nasdaq has
been the situation for the past several weeks.

The most positive thing about yesterday’s session is that the
gains occurred on higher volume, but turnover in both exchanges was still well
below average levels. In the NYSE, total volume was 23% higher than the previous
day’s level. The Nasdaq volume similarly increased by 19%. Although the gains on
higher volume technically caused both the S&P and Nasdaq to register bullish
“accumulation days,” volume in both exchanges was still approximately 35%
lighter than 50-day average levels. With institutions remaining largely on the
sidelines, don’t get too excited about price movements in either
direction during this holiday week. Again, we will know the true intentions of
which way the mutual funds, hedge funds, and other institutional traders want to
take the market after New Year’s Day has passed.

Although we are already showing a profit with our long
position in the StreetTRACKS Gold Trust
(
GLD |
Quote |
Chart |
News |
PowerRating), the Market Vectors Gold
Miners
(
GDX |
Quote |
Chart |
News |
PowerRating) is also setting up for a potential long entry. While GLD
mirrors the price of the spot gold commodity, GDX is tied to the price movement
of a basket of individual gold mining stocks. As you may recall, we bought GLD
on December 19 when it corrected down to triple convergence of support of its
primary uptrend line, 50-day MA, and 200-day MA. So far, its primary uptrend
remains intact. The price of spot gold obviously affects the price of the mining
stocks, but the two do not necessarily move in sync with one another all the
time. GDX bounced off support of its 50-day MA two days ago, and closed
yesterday right at resistance of its three-week downtrend line. If GDX rallies
above yesterday’s high, it should resume its primary uptrend that began with the
low of October 5. This is illustrated on the chart below:

Curiously, we continue to see a clear divergence between the
relative strength in the blue chip Dow Jones Industrial Average and the
tech-heavy Nasdaq Composite Index. Yesterday, the Dow actually closed at a fresh
six-year high, but the Nasdaq merely ran into resistance of its 20-day moving
average and finished in the middle of a six-week sideways range. Further, the
Dow only corrected down to support of its 20-day MA, but the Nasdaq dipped below
its 50-day MA. Looking at the daily charts below, notice how the Dow has no
overhead supply to contend with. The Nasdaq, however, could easily roll back
over to test its 50-day MA and December 26 low:

Although not shown, the S&P 500 has a similar chart pattern as
the Dow. The S&P only corrected down to its 20-day MA and nearly closed at a new
high yesterday as well. When the major indices are showing such divergent
patterns, it indicates the presence of a tug-of-war between the bulls and bears
that typically leads to indecisive and choppy overall conditions. While it’s
certainly possible for the S&P and Dow to continue rallying with the Nasdaq
lagging behind, rallies driven by such leadership are usually short-lived. Soon,
we should see the resolution of either the Nasdaq catching up and moving to new
highs, or the S&P and Dow correcting down to the vicinity of the Nasdaq. A
healthy Nasdaq is necessary in order to confirm the strength in the S&P and Dow,
so traders will be watching the coming week closely to see which scenario occurs
first.

Open ETF positions:

Deron Wagner is the head trader
of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com),
which he launched in 2001. Wagner appears on his best-selling video, Sector
Trading Strategies (Marketplace Books, June 2002), and is co-author of both The
Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader
(McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and
Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and
financial conferences around the world. For a free trial to the full version of
The Wagner Daily or to learn about Deron’s other services, visit

morpheustrading.com or send an e-mail to

deron@morpheustrading.com .