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October 06, 2003

Market Letters Digest
by David Petch

Important Notice

This will be my last article posted on this forum. I am going to be a contributor with Captain Hook at www.Treasurechests.info to complement each others market research. The articles will be in a weekly format as the past number of issues has been. Any questions or comments can be forwarded to ITMmyFAV@aol.com.

A Further Brief Elliott Wave Lesson

The past issues usually have a blurb on describing Elliott Wave, and here is one briefer note. Impulsive waves can move upwards or downwards. The chart below shows what an impulsive wave looks like. There are three advancing waves, with two corrective phase's in-between. To try and condense the rules is impossible. Books are written with 200-300 pages on the subject. Within the corrective phases, corrections can have the appearance of a flat, zigzag or triangle. Occurrences of these, and rules are significant, especially triangles. Triangles are by far the most complex portion of describing an Elliott wave pattern. Complex corrections with a 3-3-3 structure (flats, zigzags, triangles in combination) are part of larger degree structures, and have post pattern consequences. This brief description should help aid in following how the wave structures are assembled. As a note, Elliott wave software from what I have read and seen posted on the Internet is not very reliable, so those wishing to learn quick and dirty, it will not happen. At least one solid year of one to two hours per night is required to be proficient.. Unfortunately, the best results usually occur from effort, and this is so true in this domain.

Elliott 101 Figure.

Current Juncture in the Markets

Last week we had a collapse in the gold price, and extension in the S&P 500 index which have altered some projections and may provide insights of change occurring during the next few years. The events are bearish, and will have ill consequences for those not properly prepared. Extensive analysis of the US dollar index, Gold BUGS Index, S&P, Oil Index, natural gas index, and the 10 year treasury index are covered to try and paint a clearer picture for what is going on.

US Dollar Index

Figure 1 shows the daily US dollar chart with Bollinger Bands (BB) and Full Stochastics. The pattern painted in the USD is still quite bearish. Despite Friday's spike up in the USD, the full stochastics are still in a very bearish trend. The best scenario one could hope for would be 2-3 months of sideways action prior to a buy signal being issued, given the steep slope of the pattern so far. The BB's are starting to get set for another ribbon formation.

Figure 1 Daily US Dollar Index with Bollinger Bands and Full Stochastics.

The Elliott wave count of the USD is shown in Figure 2. The counts for the USD index were lowered one degree due to the overwhelming evidence of the coming downside of the US dollar index. IT appears that wave (1) of intermediate degree bottomed, now up in wave (2) heading to fill the gap denoted in the filled green oval. Gold and gold shares should experience further pressure as the USD rises correctively. What stands to happen when the USD moves below the wave (1) has yet to be seen. It is thought that this could trigger the stock market to decline and trigger margin calls etc. on all paper stocks. A move to the other currencies is a strong possibility. I am going to try to examine currencies in the future to determine the most likely candidates like the Canadian and Aussie dollars. Wave (2) should last 1-2 weeks, and of course could move beyond the gap, although unlikely at this point.

Figure 2. Elliott Wave Analysis of the US Dollar Index.

Amex Gold BUGS Index

I first want to stress that I am very bullish on gold for the long term, however the short term does present some challenges. Figure 3 illustrates the daily Amex Gold BUGS Index (HUI). This shows something different, the HUI in log scale. This puts the wave structures into perspective relative to each other. We did get a drop this past week, and now we have to wait and see if the pattern is a continuation of the advance of if the wave pattern is complete and wave [2] is now underway. From an Elliott perspective the HUI pattern is minimally complete, but it is an ugly pattern and we could get the %K and %D lines flirting with each other. The Bollinger bands (BB) are going bearish. I took profits in stocks that advanced significantly such as CDE and BGO, and are waiting for further confirmation for a reentry position. I will probably be selling remaining stocks into strength. The 55 MA BB (green) hooked above the 21 and 34 MA, suggestive of a braking halt to the advance. The NASDAQ, Nortel etc. had a similar pattern setup in 2000 prior to the decline. I am not stating that will occur, just an observation. The full stochastics with the setting of 144,13,89 produces no false signals, and we are nearing a crossover. From a mechanical trading perspective, I would not want to bet against this indicator.

Figure 3. Daily HUI Log scale with Bollinger Bands and Full Stochastics set at 144,13,89.

Figure 4 shows the HUI in linear scale. The best way to ensure a top is in is to examine as many time frames as possible. This chart is in linear scale as opposed to the prior being in log scale. Watch the lower 34 and 21 MA BB interactions. As mentioned the hook of the upper 55 MA is bothersome, which indicates the rally is complete. Flare-ups of the upper BB's do not usually occur until the top comes in. The slower MA near the top curling over spells a more rapid decline due to the rapid slowdown in short term momentum. Everyone expects a fifth wave to occur. If it did occur, then it was a short terminal impulse pattern. A very very tough pattern to read. The MACD setting of 5,34,5 is an accurate measure of the trend. Watch carefully, as the lines are nearly crossed.

Figure 4. Daily HUI in linear scale with Bollinger Bands and MACD.

Things for the Elliott wave counts are a little mixed today, with the shorter-term count first as shown in Figure 5. The alternate count is shown in gray (circled) with the preferred count in color. Based upon further examination of the red flags mentioned in the first two HUI charts, I felt compelled to go with the bearish scenario for now. Refer to the next figure to see the larger term downward projection. IF this is complete, the trend lines drawn in account for the very short waves 4 and 5 relative to the rest of the pattern. A probable bottom would be at least a return to the start of wave (4), or around 120-140. I have not gone into too much of a concern on the degree below wave [2] right now due to the downside involved. If we are in wave 4.(5) right now, the alternate count shows a complex correction thus far (flat-x-??). This wave 4 would have more alternation and a higher intricacy (more sub-waves) than wave 2, suggestive wave 5 would be extended, and the bullish scenario presented two weeks ago lights up. Based upon the amount of this pattern remaining, the 50-61.8% retracement levels would be the targets. Those that sold near the top could get in easily if wave 5 was to still develop. This would be evident in the patterns. However, the bearish stance (see Figure 6) shows the bearish view, based upon analysis of the other indicators.

Figure 5. Shorter term Elliott Wave Analysis of the HUI.

Figure 6 below shows the longer term Elliott Wave counts. Refer to Figure 5 for the shorter-term alternate count. If there is one more leg up, the Fibs at that point will be examined in relation to the other waves of the impulse for a target. However, assuming the wave pattern since 2000 is complete, then the 38.2% to 50% Fib retracements are the target zone (145 to 125). Corrective waves are generally 1/3 of the time of the move up, so a bearish trend could be in place for six months, up to one year. Review all the information carefully on these figures for aiding in determination of how things progress. Elliott wave analysis is modeling, and when things change, one must be able to change their count quickly, and react accordingly. The Fib targets for the decline is shown below. The worst bearish case would be that we completed a double zigzag ((W)-(X)-(Y)) and the bear market since 1981 was still in force (I do not believe this pattern has much weight right now, but is in the realm of possibilities). I will not mention targets as this is of lower probability.

Figure 6. Longer term Elliott Wave Analysis for the HUI.

S&P 500 Index

The S&P 500 index with BB's and full stochastics is shown in Figure 7. So, what is going to happen here....very good question. The price back in Elliott wave terms is dealt with in Figure 8. Here the S&P has been fighting a negative divergence since July 2003. The BB's appear to be getting set to rally higher. Watch the lower 21 and 34 MA. IF these two merge in the next few weeks, the rally is capped. I am standing aside on much commentary here, as the market numbers being fixed, GDP, job numbers etc. are causing this wave pattern to extend to the point of lunacy. The weekly S&P chart is bullish, suggestive the October 2002 lows will hold over the course of the next year. Gold could be on hold for up to one year or so until the underlying market strength begins to weaken.

Figure 7. Daily S&P 500 Index with Bollinger Bands and Full Stochastics.

The shorter term Elliott wave count is shown in Figure 8. The Elliott wave pattern should have ended, but instead has chosen to extend. There are two possibilities shown with the preferred in color and the alternate shown in gray. The move up from the 29^th of September counts best as an impulsive wave, which lends more support to the preferred count. It could form a zigzag for a corrective wave, and then move down afterwards, but I have to stick with the bullish implications here. The pattern suggests we will take out the 1040 high, and possibly move up to 1100-1150. This is a make or break point for the S&P though. We either continue north with the further expansion of the fifth wave, or we decline at this point until we hit 790-830. If we do rally much higher, then my longer term count of the S&P would have to become more bearish, and a visit to the 600 level is automatically a gravitational point. The longer we continue without a significant correction, the worse the next decline will be. This is up to Mr. Market to decide. IF I were George W., I would be trying to get the markets to correct now rather than later. A correction occurring later will have a bad economic period around mid-2004 wiping out George W.'s chance for re-election.

Figure 8. Elliott Wave Analysis of the S&P 500 Index.

Oil Index (XOI)

The XOI was in a very complex corrective pattern starting in 1998 and finishing in March of 2003. The stochastics are in an up-trend, but the EW pattern appears to be in a corrective pattern possibly right now within a bullish advance. Oil has a very very bullish longer term pattern and does deserve a portion of ones portfolio in this area. Bollinger bands are currently in a purgatory-type state. The outcome of the BB's will rest in the hands of the full stochastics. The EW chart gives a better perspective as to where the chart pattern is heading.

Figure 9. Daily Oil Index chart with Bollinger Bands and Full Stochastics.

Figure 10 shows the Elliott Wave analysis of the XOI. The XOI finished a very complex pattern with completion of a terminal impulse. The labeling of terminal impulses (ending diagonals) occur in waves 5 or C. It is an impulse, except each impulse wave has an internal :3 structure rather than :5, and waves 2 and 4 have overlap. The current move up is going to be very bullish based upon the charts. Wave [I] of the larger degree pattern underway did not subdivide, so we can assume wave 3 or 5 (most likely 3) will be the extended wave. This count has not changed since my last look at in June. The correction in wave [ii] retraced precisely 61.8% of wave [i]. A higher oil price in the not too distant future does not bode well for an economy supposedly on its way to recovery. Gold and gold stocks will be bullish once the correction they have coming up is complete. The HUI/XOI ratio has been in favor of the HUI breaking out against it for the past few years. I would expect a change in the future i.e. the XOI advancing quicker in the shorter term than the HUI.

Figure 10. Elliott Wave Analysis of the XOI.

Natural Gas Index (XNG)

Figure 11 shows the daily XNG in log scale with BB's and full stochastics. The XNG is in full-blown bullish mode. I have not looked at this index for a long while, and the correction we had was shallow. Rising energy prices is not something an economy on the verge of and economic turnaround are supposedly good qualities. The stochastics are in a bullish up-trend with the BB's positioned to move to the upside with a ribbon formation on the lower (bullish).

Figure 11. Daily XNG in log scale with Bollinger Bands and Full Stochastics.

The Elliott Wave count of the XNG is shown in Figure 12. The XNG has completed wave (20 of intermediate degree and is currently in wave (3). No further labeling below this degree was included due to the uncertainty in the count. It is bullish though, and we can anticipate higher natural gas prices based upon this chart. Higher oil and natural gas prices translate into higher cost of goods, which reduces excess spending capacity that slows money velocity. A slowdown in our current market environment could have a small liquidity crunch whereby deflation exists in paper assets, but rising interest rates and inflation to follow afterwards from no loan activity and demand of higher rates for greater risks exists.

Figure 12. Elliott Wave Analysis of the XNG.

10 Year Treasury Index (TNX.X)

Figure 13 shows the log scale TNX with Bollinger Bands and full stochastics. The 10-year treasury index is in a decline as shown with the BB pattern and the stochastics crossover of the %K and %D lines. It is thought the trend of the 10-year treasury index is going higher, much higher, suggestive of inflation some point into the future. Refer to Figure 14 for the Elliott wave chart. As of late, the bottom occurs in this index when the %K line hits the bottom prior to a crossover with the %D line.

Figure 13. Daily 10-Year Treasury Index in Log Scale with Bollinger Bands and Full Stochastics.

Figure 14 shows the Elliott wave analysis of the TNX.X. There is a lot of internal overlap in this pattern, so it is best labeled as being a corrective move down. The most recent move up was impulsive, and now in wave 2 down. Currently the 38.2% retracement of the move down has occurred thus far, and a move of 34 to 36ish is expected (see Fib retracement on the right hand side of the chart). Probably at least one more month to the downside exists prior to moving upwards. Observe the daily 10-year treasury chart, the 55 MA Bollinger Bands hooked well above the other two and we have seen a sharp decline. Something like this could be expected with the HUI. The rising price of the cash index here is suggestive of higher interest rates in the coming future. Many bearish factors considering n all out attempt to get the markets and economy turned around appears to have been futile thus far.

Figure 14. Elliott Wave Analysis of the 10-Year Treasury Index.

Summary

1)  The US dollar index is in a longer-term decline, with a short-term corrective move upwards expected. Given the speed the US currency can move in a day, price targets are the most accurate. A move to 95 would represent a 38.2% retracement of the entire decline since the beginning of September.

2)  The HUI index has two possible Elliott wave counts, either we are in a wave [iv].5 correction, or we completed the entire pattern move since 2000. Both have immediate downside, with the latter being more severe. When we do bottom in the coming weeks/months, it will be easy to determine the future advancement projections for the index. Going long on gold stocks could pose risk in the short term.

3)  The S&P 500 index pattern suggests further upside to 1100-1150 if the pattern plays out as suggested. The alternate count is that we are completing a flat prior to further downside. The move up last Friday counts best as an impulsive wave, increasing the probability of the bullish scenario. Should this occur, then my hypothesis for this being wave [A] of a larger degree flat is negated. Downside to 600 would exist as a strong probability due to the severe overbought conditions present right now.

4)  The Oil index appears to be in a bullish pattern right now, after a near five year corrective pattern. The XNG also is in a bullish up-trend. Higher energy prices are a drag to any economy, and higher prices will quickly remove any excess capital from the system.

5)  The ten-year treasury index is in a corrective phase of an impulsive move upwards. This is a signal of inflation in the coming years.

6)  Putting it all together, The USD advancement and then a decline below 92 could signal some deflationary pressures in the future. This would affect all stocks gold or regular shares. A monetary shrinkage would imply the above scenarios. Higher oil and natural gas prices could occur during a deflation period due to lower inventories etc. In the 1930's the US was swimming in oil. Currently oil shortages are around the corner, so supply and demand has the potential to negate any deflationary swings. Ten-year treasuries signaling higher inflation rates in the future are highly probable after a liquidity crunch.

Well I hope that the articles presented have been enjoyable for people and educational. Anyone wishing to see future issues of Market Letters Digest are requested to visit www.treasurechests.info

Good luck to all, and best regards,

David Petch
TreasureChests.info

Treasure Chests is a market timing service specializing in value based position trading in the precious metals and equity markets, with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven to be very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested discovering more about how the strategies described above can enhance your wealth; please visit our web site at http://www.treasurechests.info.

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