2008 Plunge All Over Again or Merely a Quick Correction?

By: Przemyslaw Radomski | Wed, May 26, 2010
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This essay is based on the Premium Update posted on May 21th, 2010

The recent carnage on the general stock market corresponded to a visible downturn in the mining stocks, which consequently caused many PM Investors to be worried about the future performance of their PM assets. In the following essay, we'll provide you with our thoughts on that particular topic and let you know what appears to be the most likely short-term outcome. Let's start with the long-term SPY ETF chart, which allows us to analyze volume (charts courtesy by http://stockcharts.com.)

SPY

During the past few weeks, we saw a slight bounce followed by decline, short uptrend, and now we have seen a sharp decline. Still, we are at a strong support level created by the 50-week moving average - the blue slope on the above chart. Many times in the past this has proven to stop both rallies and declines (blue ellipses on the chart). We have also seen a spike in the volume on a weekly basis, which indicates that the bottom for this decline might have been reached - or at least that a temporary upswing is likely. Please note that this is precisely what we've seen at the previous bottoms in the past several years.

The thing that changed the most in the past weeks is the RSI indicator, which has moved much lower. Here, the RSI is based on closing weekly prices and after being above the 70 level (which is signals an overbought market), we have seen it decline dramatically. It is now below 50 as this dramatic downturn has occurred in a very short period of time.

Looking at the historical charts, we see there were two times in past 10 years where a similarly overbought condition (RSI above 70) was followed by a sharp decline that took the RSI to or slightly below the 50 level. This occurred early in '07 and also later in the same year. Please note that in both cases, a sharp rally followed.

While we can't rule out the possibility that the general stock market plunges severely in the future, it is unlikely to take place right away. Please note that even the gargantuan 2008 plunge didn't start right after the top was formed in 2007 - instead we've seen a sharp corrective upswing before the end of the year.

SPY

Looking at the long-term chart this week we see a second spike in the daily volume and this normally corresponds to lows in the index. Moreover, the RSI has fallen below 30 and this level has frequently coincided with market bottoms in the past. The question everyone has today is are we seeing 2008 all over again?

We need to have a confirmation before we can agree to this premise. So far there is no evidence that what we've seen recently is more than just short-term correction. Once bearish signals are confirmed, this could actually be the beginning of a significant downturn trend - but until we see that confirmation, the trend remains up. Strong resistance levels at this time have not broken. This suggests that the odds still favor a rally ahead even though the decline appears very scary.

Since stocks have recently plunged severely on huge volume, at least a small rally is likely. The key point to monitor is the volume during the following upswing. There were two cases in 2008 when the volume was low before the next downturn began. It was extremely low in the period prior to June and September 2008 and the downtrends materialized respectively in the middle of 2008 and in October. This is one of the things that we will watch and monitor the days and weeks ahead.

Additionally, in 2008 we've seen a severe under-performance of PM stocks relative to the general stock market. This occurred very visibly before the final part of the market's decline, and also - less visibly - in the middle of 2008. We have not seen this in the PM sector recently. Even though the decline in the PM stocks has been huge and rapid, gold stocks didn't drop more than the main stock indices. The major stock indices are much below their March low, while the HUI Index is clearly above it. This is certainly not what we would call underperforming.

Speaking of the precious metals stocks, let's take a look at the long-term HUI chart.

HUI

With respect to the precious metals stocks, the risk/reward ratio for speculative investments has not been favorable since May 12th (we've sent a Market Alert to our Subscribers). The significant decline in PM stocks that followed week was much greater than the decline in gold itself. This is clearly visible on the above HUI chart above, which shows that the downswing has been stopped by the 50-day and 200-day moving averages. Still, this, and the RSI close to the 30 level suggests that PMs are not likely to fall any further.

GDX

The short-term chart confirms this. Here, we see additional two support levels. The lower border of the rising trend channel and the 50% retracement level of the February-May upswing provide this additional support. The RSI also indicates a possible buy signal.

Summing up, whether or not we will see much higher prices in the following weeks will depend on the PM sector's performance relative to the way they are influenced by other markets. Early in 2010, during the final part of a rally, actually a correction within a bigger decline, we saw low volume during up-trends and rising volume during downtrends - as marked with a black ellipse on the above chart. This was in fact, confirmation of a fake rally and the future move was likely to be lower. Should we see a similarity to this pattern develop, we will suggest exiting the market. As of now, we have yet to see evidence that the trend has broken. Although things might appear very bad today, this was also the case in October '09, which was followed by a big rally. So far there is no evidence suggesting that this pattern has been invalidated. Conversely, so far we've seen the GDX ETF rally on average-to-strong volume (not visible on the chart above), which supports the bullish case.

To make sure that you are notified once the new features are implemented, and get immediate access to my free thoughts on the market, including information not available publicly, I urge you to sign up for my free e-mail list. Sign up today and you'll also get free, 7-day access to the Premium Sections on my website, including valuable tools and charts dedicated to serious PM Investors and Speculators. It's free and you may unsubscribe at any time.

Thank you for reading. Have a great and profitable week!

 


 

Przemyslaw Radomski

Author: Przemyslaw Radomski

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Gold & Silver Investment & Trading Website - SunshineProfits.com

Przemyslaw Radomski

Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who takes advantage of the emotionality on the markets, and invites you to do the same.

His company, Sunshine Profits, publishes analytical software that anyone can use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem that may never be solved, PR has changed the world of trading and investing by enabling individuals to get easy access to the level of analysis that was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals sector. For that reason it is his main point of interest to help you make the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for professional excellence and ethics for the ultimate benefit of society.

Sunshine Profits enables anyone to forecast market changes with a level of accuracy that was once only available to closed-door institutions. It provides free trial access to its best investment tools (including lists of best gold stocks and best silver stocks), proprietary gold & silver indicators, buy & sell signals, weekly newsletter, and more. Seeing is believing.

Disclaimer: All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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