Thoughts on Last Weeks Big Rally(Excerpt)

By: Michael Swanson | Mon, Apr 21, 2008
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Hey one quick note before we get into the market - I'm ahead of schedule and almost have the Stock Market Mastery Course complete! Although I'm going to release it in full on May 1st, the day before I'm going to run a 50% off 24-hour pre-release schedule so mark next Wednesday on your calendars.

Now as for the market I got dozens of emails this weekend asking me if I think the bear market is over now. I spent the weekend scanning through articles and commentary and virtually everyone thinks the market is going up from here. On TV the CNBC and Fox News commentators were ecstatic Friday and this weekend following the big rally that day while CNN is calling for a top in oil, gold, and commodities and a bottom in the dollar that they see driving a huge rally over the next few weeks. Most of the emails I got asked something to the effect if I think the positive earnings news or these news stories changes anything?

In a short answer not in the long run. The bull market in gold and commodities is not over nor is the bear market for the US stock market. That said we've had a nice bear market rally since the March low and it went beyond where I thought it would go last week. It could go a few percentage points higher from here, but I'm still skeptical as I'll explain why in a few minutes. But first I need to talk about bear markets with you.

I traded through the last bear market from 2000-2003 and had some of my best years by betting against the market on the short-side and buying into stocks that were in sectors that bucked the broad market trend. These were sectors such as health care, medical research stocks, casinos, and auto parts from 2000 to 2001, and finally gold in 2002. During this time I personally heavily shorted the market and I wrote about what I was doing openly just like I do now.

From what I would gather just about everyone who read what I said back then totally ignored my comments about the stock market being in a bear market. I know very few people shorted the market, because I got very little feedback discussing short selling. Those that followed me just ignored my talk about a bear market and focused on the stocks and sectors I like on the long side.

What I took from this is that the general market cannot face the reality of a bear market or attempt to bet against the market in a bear market until the bear market is almost over. They have simply been so conditioned by the bull market that came before them to think about going against the market is too difficult for them to do. We've been taught since we were kids that you should save and invest so for some to think about bear markets means discounting belief systems that they have held for their entire lives.

What is more bear markets themselves provide occasional huge one day rallies and bigger bear market rallies that retrace losses that create both fear and optimism among market participants at the same time. The rallies make the press optimistic about the market while market participants watch the market go up and get fearful that they are going to get left behind. Most cannot sit out a rally with the knowledge that the market is going to eventually come back down to them or that it is better to wait for better conditions before investing. The bottom line is that people are motivated more by greed than a fear of losing money and this is why people hold on or double down on their positions during bear markets until they are practically wiped out.

That can make for a tough time for someone in the newsletter business, because if you remain bearish during a bear market it doesn't help you win subscribers, because very few people are interested in short selling and many others don't want to hear about bear markets. I found this out in the last bear market and the same thing is happening again. I've been bearish on the market since late last year and explained the signs that I thought would point to a new bear market before the drop began. Those signs all transpired back in December. Since then I've taken some short positions and gone long stocks a few times. I've gotten lots of emails and feedback about the long positions, but almost none about the short positions. From what I can tell on the website there are three or four people who have posted about taking short positions in the past few months while dozens have talked about gold stocks. Back in January I bought near the panic bottom and everyone was interested, but when I shorted the other week I didn't see much interest. That's good in a way since the market went up last week, but the point is that I'm worried more about the long-term.

The market has rallied hard the past week. It could top out right here or it could go up more. I can't know what it will do for certain, but I know its still a bear market and people who try to play into a bear market rally if they don't use stops will get burned. I don't want that to happen to you. Investors should ignore the market rally and ignore the news. The market is not going up, because the earnings news is good. These are purposely low estimates that got beat last week. The market went up, because when the market is in an uptrend the news is all good. When the market is in a downtrend good news gets sold. The market has been having a bear market rally and will continue to go up until the rally exhausts itself.

Most people should make money by continuing to focus on the sectors still in bull markets and buying them on dips - which means commodities - and by having a good cash position that you can deploy in a year when this bear market is really over. Those that can should use a good portion of their account to short rallies when the market gets overbought with tight stops. But no one should just be diving into the broad market right here just because there is a big rally that makes them scared that they are going to miss out. But this is exactly what the masses do.

In the past month I've added two new gold stocks to the WSW Power Picks list. The last one was added on Thursday and is up almost 10% already. On Friday it went up even though gold stocks as a whole dropped. They are both small cap gold stocks.

One thing that I keep a close eye on is the HUI/gold ratio. This ratio has been in a slight-downtrend since October. What this means is that gold has performed better than gold stocks overall during this rally. However, this may change in the coming weeks. You can draw a downtrend resistance line on the HUI/gld ratio. It appears that within a month this line will be broken to the upside. Once that happens we should see a sharp rally up to and beyond the March highs for gold stocks. I also believe that in such a rally leadership will start to shift to the smaller Canadian juniors stocks.

This weekend I went through 800 of the most actively traded Canadian juniors. I wrote down about ten that look like they will be interesting buys over the next few weeks. As a whole though these stocks have been dead for months. Many of them haven't really gone up or down at all this year. They have just been going sideways. I think they are lining up for a big rally ahead of us and am watching them carefully. If we get another big gold stock rally these stocks are more attractive to me now then the larger cap gold stocks, such as Kinross, EGO, and Yamana. I still like these stocks, but they had big runs since August. These smaller stocks haven't and there are small juniors that actually are cheap on a fundamental basis. I already picked two out on the website, but there are more to be found.

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Michael Swanson

Author: Michael Swanson

Michael Swanson,

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