Value of Perfect Information

Jim O’Neill, the clever Goldman Sachs analyst who came up with the term “BRIC” a decade ago, has cooked up a new, catchy investment theme. Get ready for the “N-11”, shorthand for the “New 11”, a gaggle of early stage emerging markets who will become the inheritors of the BRIC’s high growth rates. The basic idea is to surf a global wave of coming GDP and per capita income rises. The N-11 breaks down into four sub categories:

High Income: South Korea
Upper Middle Income: Mexico, Turkey
Lower Middle Income: Egypt, Iran, Pakistan, Indonesia, Nigeria, Philippines
Low Income: Bangladesh, Vietnam

Jim has come up with a basket of indicators measuring the attractiveness of each country that includes liquidity of the financial system, bank deposits, central bank assets, private credit, stock market capitalization, outstanding currency, public and private debt, and for some countries, aid inflows. Before you rush out and load the boat with Iranian names, let me tell you that investing in some of these places is easier said than done. This is really a call on economies, and not local stock markets. Only a couple have ETF’s. I have already recommended in the past, with great success, South Korea (EWY) (click here for the piece), Vietnam (VNM) (click here and click here for more info on Vietnamese stock markets), and Indonesia (IDX) (click here). Jim says that the best value for money in terms of financial development is Vietnam and Egypt. Watch this space. I am going to be posting on the other countries in this list as liquid vehicles become available. In a few years you are going to become as weary of hearing about the N-11 as you are about BRIC’s today. To read the full eight page report from Goldman Sachs, please click here.

US Dollar Index – Daily Chart

The past two months the dollar as been in rally mode. The last 14 days we have seen a large bullish pennant form and this pattern typically marks the half way point for the current tend. The measured move for the USD is pointing to 93 over the next few months.

Gold Futures Prices – Daily Chart

Gold as we all know is seen as the major safe haven and the price per ounce has been steadily climbing. Friday we saw the major indexes sell down very hard but both the dollar and gold posted some solid gains. Gold does looks as though it needs some time to digest the recent move higher and this could take a week or two before anything exciting happens but I am on the lookout for low risk setups.

VIX – Volatility Index – 60 Minute Chart

This index measures the fear in the market. When fear is high and everyone is selling their positions we see the VIX jump in price. Over the past month we can see a possible Head & Shoulders pattern forming. If this pattern unfolds like it should then we will see the price of equities bottom in the coming week with the VIX dropping below the blue neckline. The old saying is “When the VIX is High is time to Buy, when the VIX is low its time to Go”.

Put Call Ratio – 60 Minute Chart

In short, when the put/call ration is over 1.00 then there are more traders/investors buying Put Options than Call Options. Put options are when people are buying leverage to take advantage of lower prices. My thought/opinion about this is when more people are trading with leverage anticipating lower prices, I figure they have sold all their long positions and are now using leverage to profit from lower prices. Well if the majority of individuals have sold everything then in reality there should not be much left to be sold… So I feel this correction which started in April is almost finished.

NYSE Advance/Decline Line – 60 Minute Chart

This is one of my favorite charts to look at. While there are several indicators, market internals and technical analysis needed to clearly determine if the market is currently overbought or oversold, this chart is one that can help give you a good idea if you should be looking to buy, short or just stay in cash for the time being.

SP500 Futures Prices- 2 Hour Chart

The SP500 has been up and down like a yoyo with some very dramatic moves. Up 2+% day down 2+% the next… very sharp and powerful moves can be both every profitable or costly if not traded correctly. Last week we caught a nice 2% gain in less than 24 hours which was an exciting trade. It looked at though the market was about to breakout to the upside and possibly reach the 1150 level but early Friday morning there were rumors about some Euro bank having serious problems and that was just enough to cause a domino effect sending the market lower throughout the entire session closing on a very strong negative note for the day/week.

That being said the market internals are indicating that equities are oversold at these current prices and a bounce is due any time. With the panic selling on the NYSE Friday reaching 119 sell orders for every 1 buy order I think we will see some follow through next week with lower prices, then a rebound once investors finish selling everything they own at which point we will be looking to get involved again.

Weekly Trading Conclusion:

In short, money continues to flow into the safe havens (Gold & US Dollar). The major indices are showing extreme panic selling and look ready to in the next few days. There is a possibility that the market could break down and start another major leg lower which is a big concern to me. I will be glued to the market internals and support levels for the major commodities and equity sectors in hopes to catch the bottom or to avoid another melt down.

If you would like to receive my Daily Pre-Market Videos and Trading Alerts please checkout my website at: www.FuturesTradingSignals.com.

It’s sad to say but I’m afraid 90/95% of all retail traders/investors are not going to successfully ride the gold bull. The reason of course is that they are deathly afraid of draw downs. It’s glaringly apparent every time gold pulls back or suffers the slightest correction. Immediately a slew of traders come on the blog and warned of impending doom. “Gold is going to $600″ (think Elliot wave). Some are even brave (maybe I should say ‘foolish’) enough to short. Here is one we hear a lot lately, “miners are going to get crushed if the stock market enters a new leg down in the secular bear market”.

Pure nonsense!

Let me show you what happened to gold and miners during the 2000-2003 bear market.

During one of the worst bear markets in history gold rallied over 50% and miners well over 200%. So this notion that the precious metals sector has to get hit during a bear market is simply ludicrous.

Now I know what you are going to say, “Just look at what happened in ’08″.

The reality is that the crash in ’08 was a very special set of circumstances that aren’t likely to repeat. Up until September the bear market was following the normal path most bear markets follow. Slow grinding declines followed by explosive counter trend rallies. Gold was holding up amazingly well during this period as were miners. Both were actually up significantly during the first 5 months of the stock market bear. It wasn’t until gold entered a normal D-wave correction in March of ’08 that either corrected at all.

In September a rare event happened that drastically changed the entire fundamental picture of the bear market. At that time roughly $700 billion in debt came due. The financial system needed to roll that debt over but couldn’t as the credit bubble was in the process of imploding. That led to one of the few true stock market crashes in history.

The ensuing panic led to a selling climax in every asset class even including, to some extent, gold. The actual price of physical gold never even came close to dropping to the levels of the paper market. Smart money investors were taking advantage of the irrational selling by buying up every single available oz. of physical gold on the market. At the time premiums on physical were over $100 above the paper price.

The point I’m trying to get across is it took a very special set of circumstances to create the kind of selling climax that could take down the precious metals sector. Those circumstances are not present today. The EU has already gone to the printing press to halt their debt problems. The US has done away with the mark to market rules and Ben stands ready to print so we have no looming debt crisis in our future.

So if we are about to enter another leg down in the secular stock market bear the odds are it will be another slow grinding affair, very similar to the 2000-2003 bear. There will be plenty of sharp counter trend rallies and one can bank on the Fed throwing more and more trillions of freshly printed dollars at the problem all along the way.

And that, my friends, is the fundamental bedrock of the gold bull.

Now let me show you a long term chart of the last great secular bull market.

This is just about text book for a big secular bull market. We see a very extended period of consolidation below a key resistance level. Eventually that resistance level gets broken. Once it does it’s like a damn breaking, the force then becomes unstoppable, ultimately reaching heights far beyond what anyone can foresee at the original break out.

In oil’s case the secular bull rallied almost 300% above the $40 breakout level, topping out with a massive parabolic move lasting about a year and a half (remember me saying bubbles tend to last about 1 to 1 1/2 years as the final phase tops out?).

I want to point out this happened in oil, a commodity that was virtually impossible for the average Joe to invest in. This was a bubble driven purely by the the investing community. Remember this because it’s important.

Now let’s take a look at the next secular bull, one that’s still in the baby stage.

Gold has just recently broken out above the old 1980 high of $850. It hasn’t even doubled yet much less rallied 300%. Now if you think gold rallying to $3500 is ridiculous you are absolutely correct. There is no way gold is going to stop at a mere 300%.

Unlike oil, gold is readily available to the public and ultimately that is what drives the final stages of a secular bull market/bubble. When the public comes into the market their panic buying drives the final parabolic move to unbelievable heights. We saw perfect examples with both the tech and housing bubbles. The public was deeply involved in both.

And now, for the topping on the cake. The precious metals markets are infinitely smaller than the stock market, real estate markets or energy market. That means it won’t take anywhere near as much money to drive these markets to incredible heights.

Look at that chart of oil again. A 300% gain in a very large liquid market without ever drawing in any perceptible buying from the general public.

Now look at that chart of gold again, only this time with fresh eyes. The possibilities are simply staggering. I wasn’t kidding when I said this will be the greatest bull market any of us will ever see in our lifetime.

If, and this is a big if, you can ignore the nonsense from the Nervous Nellies or the gold Bears (a breed destined for extinction) and just hold on to your positions you will ultimately reap unimaginable rewards as this bull progresses.

Now I will say that yes, there are times to take profits in bull markets. You take profits when gold and miners are stretched far above the 200 day moving average. Everything eventually regresses to the mean. So when we see the HUI 40-55% above the 200 DMA then yes, you should think about selling at least some portion of your positions. But to sell positions with the miners 3% above the 200 DMA is … well, it’s just plain dumb. This isn’t the time to sell it’s time to buy, buy, buy.

Let me say this as plain as possible. If you want to get rich from this, the largest bull market you are ever going to see, you don’t listen to the traders and you certainly don’t adopt their flawed strategies. You simply can’t think like that if you want to ride this bull. You need to think like a value investor. When you see value you scoop it up no questions asked. And if the market is foolish enough to give you an even better bargain down the road you buy more.

Unfortunately here is what happens. Retail investors are unable to buy value. For the average retail investor to buy he needs emotional confirmation. I see this all the time. “Wait till the breakout for confirmation before buying.” The problem with that approach is that most breakouts soon fail. If one waited for the recent breakout above $1225 to buy they then had to weather an immediate draw down.

I saw this in spades at the December top. Retail traders entered in droves during that time. They were getting the emotional confirmation they needed. Then when gold corrected they either got knocked out for a loss or they held on just long enough to get out even. Most simply don’t have the patience to ride the bull on his terms. They want the bull to do what they want, when they want. I suspect more investors have been lost to boredom that draw downs.

The best strategy right now is to just sit tight. Remember this is still just a baby bull and it has a long long way to go yet.

GoldScents is a financial blog focused on the analysis of the stock market and the secular gold bull market. Subscriptions to the premium service includes a daily and weekend market update emailed to subscribers. If you would like to be added to the email list that receives notice of new posts to GoldScents, or have questions,email Toby.

I have to wonder, are we entering the ending phase of this cyclical bull?

For some time now I’ve noticed the similarities between the ’02-’07 cyclical bull and what we’ve experienced since March of last year. The one difference is that this time we’ve truncated the middle phase of the bull. I suspect that was a direct result of the massive liquidity Bernanke … and all central banks have pumped into the system.

Both bulls exhibited powerful moves out of the bottom followed by a 9% correction separating the second leg from the third. In the ’02 – ’07 bull we then entered a 2 year phase were the market ground higher. That phase is missing from the current bull.

What followed the ’06 correction was a powerful runaway move into the February ’07 top. That persistent rally skewed sentiment extremely bullish at the time. We saw the exact same thing develop as the market entered the runaway move out of the February 5th bottom. At its peak sentiment had reached bullish levels exceeding what we saw at the top of the last bull market in the fall of ’07.

In ’07 the runaway move led to investor complacency and severely depressed put buying. The same thing happened at the recent top in April. Investors became terribly complacent. Protective put purchase fell off the chart. The market had no safety net under it. In that condition it was at risk for a crash if investors all tried to head for the door at the same time. They did, and we suffered a mini-crash in the spring of ’07 and again in May.

In ’07 the initial crash low was tested and broken followed by a 2b reversal.

Recently the S&P also broke to lower lows and bottomed with a 2b reversal.

Both markets experienced volatile swings as the market put in the intermediate term bottom.

Both crashes quickly moved sentiment back to extreme levels of bearishness. In ’07 sentiment turned sourer than at any other time during that cyclical bull. At the recent bottom sentiment was blacker than at any time in the last 10 years as measured by a basket of intermediate term sentiment indicators.

These kind of extreme sentiment levels are the building blocks for powerful moves. In ’07 the extreme bearish sentiment drove the market into a final double top that capped the cyclical bull.

If sentiment levels are any indication we should now be set up for at least one more explosive move higher before the fundamentals final overcome this market and drag it back down into the next leg of the secular bear.

The similarities are piling up:

Initial runaway move drives sentiment to extreme bullish levels? Check!

Protective put buying dries up leaving the market with no safety net and vulnerable to crash conditions? Check!

Mini-crash? Check!

Test and 2b reversal of the initial crash low? Check!

Sentiment depressed to extreme levels of bearishness? Check!

Volatile swings back and forth during bottoming process? Check!

If history is any indication we should now be on the verge of one more explosive move higher before this cyclical bull expires and heads back down into the next leg of the secular bear.

Last week looked and felt like a pivotal week for both stocks and commodities. The past two weeks have had investors and traders in a panic as they try to find safe investments for their money. After watching and reviewing the panic selling in the market it looks as though the majority decided to sell everything and be in cash for the time being. This is bullish for the stock market.

I will admit it has been tougher to trade recently because of increased risk levels due to the large 2-4% sell offs and rallies happening within minutes… While this is amazing for disciplined and experienced traders who are able to pull the trigger getting in and out with quick profit in the matter of minutes, this same price action can blow up trading accounts of those who do not have a trading strategy, money management and the discipline to take profits and cut losses very quickly. The speed of the rallies and sell offs is the matter of being up or down thousand of dollars in the matter of 5-10 minutes… That is one of the reasons I have stepped back from being aggressive and into more of an observation mode playing with small amounts of money and focusing on the larger trends at.

My #1 goal is to make subscribers money with the least amount of risk and watching the market swing 2-4% in minutes makes it extremely difficult to get everyone in and out positions with a profit before the market changes directions. As much as I love trading, some times the best position is to have small ones or be in cash.

GLD – Gold ETF Trading
Here is my weekly updated chart of gold as it works its way through the correction from last year. The daily chart looks to be forming a larger Cup & Handle pattern which is extremely bullish. If this pattern does a text book move then we could see GLD reach $140 and spot gold would reach the $1400 area.

That being said this pattern still has to complete the handle portion which could easily last another 4 weeks, so I am not in a panic to add more to our position.

SLV – Silver ETF Trading
Silver is in much of the same situation. Because of the added volatility in silver the charts do not look quite the same but they are similar in many ways… Silver is used a lot for industrial purposes and because the economy which is very weak still (though it is getting better) we are not seeing silver demand rise much. If silver can break this large resistance level then we could see silver surge to $25 (25%) this year.

USO – Oil Fund Trading
USO (Oil) has held up really well in the past 12 months but the recent sell off has seriously damaged the bullish outlook I had not long ago. While it is oversold and looks to have started a bounce last week the chart is pointing to lower prices over the longer term… This USO fund does have contago which makes this fund under perform the actual price of oil. The current prices of oil are still trading at a key support level and could post nice bounce if not trigger a new rally. The problem with following some ETF’s which have contago is that you do not see the real price action of the commodity. But that is were I come in as I track the underlying commodity and relate it to ETFs for you.

SPY – SP500 ETF Trading
The Stock Market (SP500) sure has been a roller coaster. The chart below shows you what happened in January for the last correction and where we stand currently in comparison. If a setup is obvious in the financial market there is a very high chance it will not work out as planned and by knowing this it allows us to be cautious and take profits at key short term support and resistance levels.

Trend Trading Conclusion:
In short, I feel gold and silver will drift around to digest the recent move up and to form the handle portion. Oil looks to have put in a short term bottom and if we get a small pullback in the coming days to test the intraday chart breakout level and touch the support trend line we could look to take a position.

We tend to see the most price appreciation during the final stages of a trend and we could have seen that on the US Dollar over the past 6 weeks. It looks as though the dollar could have put in a double top. If the dollar rolls over it would help boost precious metals, oil and stocks… But we will not know it’s a top until there is a clear trend reversal which in any case will be weeks before that type of price action can unfold.

As for the SP500, we have seen the same level of selling as we did in Feb-March 2009. High volume panic selling has ruled the market since late April. There are equal arguments for saying the market has bottomed with all the panic selling and that we should start another large rally lasting 8-12 months or one could argue this is capitulation volume signaling massive distribution of shares and now every rally/bounce will be sold… Personally I am torn between the two… but lean more towards higher prices with a multi month grind up at slow rate…

If you would like to receive my trading analysis, thoughts and low risk trading setups check out my trading services at www.TheTechnicalTraders.com.

Guest post by Mark!  

A MortiES’ premium subscriber!

Here is a chart. Potential rally next week to upper trend line around 1115. But who knows?