approach to technical analysis
Cycles - Structure - Price projections
"By the Law of Periodical Repetition, everything which has happened once must happen again, and again, and again -- and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ... The same Nature which delights in periodical repetition in the sky is the Nature which orders the affairs of the earth. Let us not underrate the value of that hint." -- Mark Twain
A Review of the Past Two Weeks
The short-term cycle bottomed on December 8th and has provided the final thrust of the uptrend which started in October. Most indices were able to eke out new highs in the past week, with the exception of the Nasdaq and the Dow.
Making reference to the latest SPX intermediate re-accumulation pattern and the projection derived from it, last week's newsletter stated: The 1314 count is probably not reachable at this time, but there are valid targets to 1278/1280 which could satisfy both intermediate and long term counts. Last Wednesday, the SPX traded up to 1275.80 and immediately sold off. It tested it once more on Friday, but sold off again.
By refusing to join the SPX in making new highs on Wednesday and Friday, the Nasdaq 100 is sending a negative signal.
Another negative signal is coming from the continuing deterioration of the breadth indices.
The BSP (buying and selling pressure) index confirmed the uptrend with strong positive figures during the rally, but since November 28 (the beginning of the topping formation) it has been essentially neutral and looks just about ready to go negative.
Oil found support when it touched 56, rebounded, and is in the process of testing it again.
The US dollar rally met with resistance at 92 a month ago. It lost a little more ground this past week, to about 90.
Gold had a spectacular two weeks, traveling almost 80 points, first up, and then down. Its action, and what it portends, will be disused in detail later on.
Current Position of the Market.
SPX: Long-Term Trend - There is a slight chance that we may currently be seeing the top of the bull market, but a much better chance that it will not come for another 3 or 4 months.
SPX: Short and Intermediate Trend - The short/intermediate-term trend which began in October is either at, or nearing, a top. A reversal is expected as early as next week followed by a decline of a few weeks.
Because of market volatility, the short-term trend is better analyzed on a daily basis with the help of hourly charts. This is done in our daily market updates and Closing Comments.
Daily Market Analysis: If you would like to receive an explanation of how I arrive at buy and sell signals and sign up for a free 6-week trial period of daily comments, please let me know at email@example.com.
Iwill repeat what was said in the last newsletter, because it still applies:
The stock market is at an important crossroad. The short-term trend is topping out and its reversal should bring some clarity about the status of the intermediate and long term trends. The key player over the next few weeks will be the 9-month cycle. It will be responsible for a decline as well as for the ensuing rally. Both will be closely evaluated to determine whether or not we have reached the bull market top, or if it will require another 3-4 months to form.
The last two weeks saw the bottoming of a short-term cycle and it is giving the market a final lift into the projection zone. The SPX reached 1275.80 on Wednesday and pulled back. Friday saw a failure to move higher, but the action at the close suggests that there could be one more attempt at reaching the 1178/1180 target early next week. Structurally this would also complete a 5-wave pattern from the cycle low on 12/8.
The bottoming of the 9-month cycle is still expected to produce a decline into about mid-January, but since its phase length is not always exactly 38 weeks, it could come a little before or a little after. This will be determined by the amount of distribution which is currently taking place at the top, and when that distribution target has been reached. Right now, we can probably expect a 35 to 40 point decline, and this will be fine-tuned after it has started.
An approaching top is usually signaled by the underperformance of the Nasdaq 100 when compared to the SPX. The following chart will show you that this is taking place.
If you also consider the negative divergence that is showing in the various indicators (see chart) and the price proximity to the target zone, it's almost a sure bet that a reversal is imminent.
Crude oil appeared to reach the low point of its correction when it touched 56. Since then, it has had a good rebound to 62 and looks as if it is in the process of testing the lows, i.e. building a base. It is too soon to determine whether this will become a re-accumulation area capable of moving the price to a new high, or if it is beginning to build a major top.
The US Dollar continues to find resistance at 92 and could remain in a trading range for some time.
Gold had a very interesting -- and revealing -- couple of weeks! My former comments on gold have been based on observing the behavior of the COTs. But it's recent price action has compelled me to do a more thorough analysis.
Actually, I have been paying more attention to the XAU (Gold and Silver Index) than to bullion itself, and since this looks very much like a major climactic, typical top in gold, I went back to the well-defined basing formation that it made between July 2000 and December 2001. When the bar chart is converted to a Point & Figure chart, a clear count can be taken across the 50 line which yields a price projection to 127. When bullion reached 538.5 last week, the XAU hit 127.00 exactly before retracing to 119.64 and closing at 122.36 on Friday.
Although the severe and immediate pull-back suggests otherwise, you can see on the P&F chart which is shown below that if the count is taken across the 52 line instead of 50, that brings the price target up to 139. So it is possible that gold could go a little higher.
These price objectives can be verified with Fibonacci ratios. Of the two that pertain, one dating back to the price action in 2000 gives us a projection zone of 107-125, and the other, a much more recent one, results in a range of 123 to 135.
Taking these projections into consideration, it is more than likely that gold has just made a major top and that this reversal could be the beginning of a decline lasting several years.
In a September 1993 publication of CYCLES, a magazine published by The Foundation for the Study of Cycles, there is an excellent article about gold cycles. These are apparently somewhat different from those of equity indices, but exactly the same as those of silver, which is pretty obvious when you compare the two indices over a period of time. The charts provided with the cycle analysis end in 1983, but by projecting forward, some major cycle lows can be forecast for gold and silver.
A 16-year cycle bottom is due in 2006/2007, and a 9-year low in 2010. Since these are the result of someone else's work, I cannot vouch for the accuracy of these forecasts, but based on the recent action of gold and the fact that it has met some long-term projections, I would not be surprised if gold was about to begin a 2 to 5-year decline.
Another cycle, the 6-year cycle appears to be very dominant and was probably the cause of the sharp uptrend into the top. Since it is still in its up phase, it may have a moderating influence in the action of the two longer cycles mentioned above, and cause an extended trading range to develop before price accelerates to the downside. However, its next low will coincide with the 9-year low in 2010.
One should also keep in mind that, according to those who track the long-term economic wave known as the Kondratieff Wave, its low point is still ahead of us, and that its last stages bring about a deflationary period. Since gold is basically a commodity, it should be impacted negatively, along with other commodities, if a deflationary period does, in fact, materialize.
The same CYCLE magazine states that the CRB index also has a well-defined 9-year cycle, and if you compare a monthly chart of gold and of the CRB, you will notice that they are almost identical. Therefore, you would also expect the CRB index to hit bottom in 2010, the year that Ian Gordon, one of the foremost experts on the Kondratieff Wave, has forecast for its low.
The first chart is an updated daily chart of the SPX. This same chart was included in the last newsletter and, as you can see, very little progress has been made, except that the negative divergence between the price and the indicators has increased. I should note that the BSP index on this chart is constructed in the same manner as the A/D index above it. I also use another form of the BSP which revolves around a "0" line, and it is this other version, not shown here, to which I refer when I mention that it is about to cross into negative territory.
Notice also, on this chart, that the MSO is still overbought. It usually drops to the bottom of its range when the low point of the correction has been reached.
The next chart is that of the weekly XAU which spans the entire gold rally. I have drawn lines connecting the main tops in order to provide a sense of the shape of the 9-year cycle.
It is easy to see why the current top could lead to a significant decline before stabilizing. Gold is a volatile medium and climactic tops, such as the present one, tend to have a sustained decline after they have reversed. Also, look at how consistently the MSO (bottom oscillator), which is now very overbought, defines the tops and the lows on this chart. I would also point out, however, that it has not yet given a sell signal.
The time period marked as "Base" on the chart is the one that was converted to the P&F graph which appears below. The XAU lends itself to particularly accurate counts, as do all stocks and indices which are traded mostly by professionals. These individuals are more uniform in their actions and create a chart pattern which is logical, while non-professionals do not follow a consistent strategy for their investment decisions. This results in less predictable chart patterns, especially when trying to determine the extent of a trend. The "count" taken on this type of stock tends to be far less accurate that one taken on the XAU, for instance. This is why, after a 5-year uptrend and the base count "filled", I believe that the XAU has essentially exhausted its upside potential.
On the other hand, since the XAU generally leads bullion, it is possible that gold could go a little higher while the XAU does not surpass its final top.
The charts of the stock indices suggest that a reversal is imminent, with a potential decline of 3 to 6 weeks.
There are indications that bullion is at or near a long term top with a significant decline over the next 2 to 5 years.