Key Breakouts And Critical Market Action

• June 17, 2005
• Mark Boucher

Key
Breakouts and Critical Market Action

 

Oil indexes and stocks are
breaking out and leading the rally higher along with healthcare.  The QQQQs have
backed off from the influence of the SOX hitting major resistance, but then got
solid support off the 200 day MA at 37 and will confirm a more solid move higher
in stocks with a break to new rally highs.  The Midcap 400 is at new all-time
highs and midcaps are leading the rally as a segment.  Commodities are moving
higher with oil.

 

 

 

A critical breakout in gold
versus both the Euro and Yen has developed and is one investors should note, I
believe.  Since the bottom of gold in dollar terms in 2001, gold has rallied 79%
from around 250 to around 450.  But in Euro terms gold has only rallied 25% from
around 280 to 350, and in fact gold hit 350 EUR in early 2002 and has been in a
long trading range ever since in Euro terms.  Until this week, when gold broke
out against the Euro above 350.  Since its late 2000 bottom against the Yen gold
has bottomed at around 920 and rallied up 63% to around 1500 by 2003, where it
began a long trading range for about 2 ½ years — until this week, when it broke
out of that long trading range.  Normally when the dollar rallies, gold
declines.   The dollar bottomed in December (when we noted in these columns the
massive over enthusiasm for the Euro as exemplified by multiple magazine stories
that the dollar was dead) and has rallied over 10% – but during this big dollar
rally, gold has been flat and this week it has started rallying in dollar terms
even on days when the dollar is strong.  Are currency traders around the world
starting to grasp the truth that NO CURRENCY doesn’t have problems and can act
as a true store of value in an environment of competitive devaluations, massive
US chronic current account deficits, and Euro-land bickering except GOLD?  If
so, then a new leg of gold bull market could be upon us, where gold begins
consistently  gaining on ALL currencies, not just the dollar.  GLD, the gold ETF,
needs to close over 43.9 or so to breakout above its downtrendline since
December to confirm this week’s clear Head & Shoulders bottom breakouts in gold
stocks and gold indexes, but investors should watch these trends closely.

 

 

The current Liquidity Cycle is
different than any other in history in many respects.  It started AFTER a bubble
popped with the largest liquidity infusion from the US and Japan in history.  A
global effort to thwart DEFLATION via coordinated liquidity infusion is how this
cycle started.  In addition the largest addition in history of new labor and a
new economy (China) is added to the mix.  The largest migration in the history
of the world from the Chinese country-side to the cities is underway.  Asia also
is adding savings to the world supply at the highest rates in history.  And
Petro-dollars are seeking a place to camp as well.

 

Thus global bond markets have
effectively neutralized much of the effect of the Feds hiking of short-term
interest rates.  Low and falling inflation rates keep this neutralization going
as excess global capital camps in bonds, and as Asian central banks buy bonds of
other countries to keep their currencies competitive and offset their own
current account surpluses with major trading partners.  In essence the market is
self regulating and saying that deflationary pressures remain enough of an
undertone that inflation is not likely to accelerate substantially,  and that
central bank pushing up yields would be a mistake. 

 

The Fed does not understand
completely the bond rally — and calls it a conundrum.  Thus he continues to
raise rates further and the bond market continues to neutralize the effect.  One
question is how far the Fed will take this game of chicken.  Lower bond yields
keep the economy in high enough gear that the Fed is not getting the usual signs
to stop raising rates.  Will Greenspan keep tightening to the point of an
inverted yield curve that kills the economy?  His current statements lead one to
expect that he will only stop hiking at a measured pace if there is a financial
accident, if the dollar appreciates significantly further, if inflation falls
clearly and noticeably, or if the labor market deteriorates markedly from an
economic slowdown.  Yet gold and commodities are giving preliminary clues that
the Fed may be about done with tightening despite his rhetoric.  Further
breakouts by commodities will confirm this — so keep a close watch.

 

The dollar is testing important
support against the Euro in the 1.17-1.20 range.  Should this major support give
way it would be ominous for the Euro. 

 

Breadth is improving on the
rally and we are getting more close calls, though breadth is not yet
substantially bullish.  We suspect that oil and commodities are not good leaders
for a sustainable long-term leg up in stocks as a whole, because pops up will
hit inflation numbers rather quickly (at least a bit).  Yet a decent upward bias
is building in the market until the major averages test their highs. 

This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 56, 84, 86, 110, and 129 with 67 breakouts of 4+ week ranges, no
valid trades and close calls in HOLX, PHM, POT, and TU.  This week, our bottom
RS/EPS New Lows recorded readings of 10, 8, 3, 2, and 2 with 0 breakdowns of 4+
week ranges, no valid trades and no close calls.  Valid signals remain in place
in LCAV on the long side and none on the short-side.    Broadening strength in
our Top RS/EPS new highs is leading us to cautiously venture to a broader long
bias in close calls here and in selected indexes we have discussed as leaders. 

For those not familiar with our long/short strategies, we suggest you review my
book

The Hedge Fund Edge, my course “The
Science of Trading,”

my video seminar, where I discuss many
new techniques, and my latest educational product, the

interactive training  module.
Basically, we have rigorous criteria for potential long stocks that we call
“up-fuel,” as well as rigorous criteria for potential short stocks that we call
“down-fuel.” Each day we review the list of new highs on our “Top RS and EPS New
High List” published on TradingMarkets.com for breakouts of four-week or longer
flags, or of valid cup-and-handles of more than four weeks. Buy trades are taken
only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts
are similarly taken only in stocks meeting our down-fuel criteria that have
valid breakdowns of four-plus-week flags or cup and handles on the downside. In
the U.S. market, continue to only buy or short stocks in leading or lagging
industries according to our group and sub-group new high and low lists. We
continue to buy new long signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors stop at 50%
long and 50% short). In early March of 2000, we took half-profits on nearly all
positions and lightened up considerably as a sea of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.

The rally is suspect because of the leadership but a little more than cautious
exposure is probably warranted and further broadening of breadth will lead us to
tip-toe further along this path. 

Mark Boucher