Is An End of the Year Rally in the Cards?
We have seen the market rally sharply off of its August lows as the S&P 500 bounced off of its 1405 support level. However, that bounce did not come with the type of bearish sentiment and panic seen in options indicators such as the VIX and put/call ratio that normally comes with the end of an intermediate-term correction. I think there is a good chance that we saw the broad market make a major top in October. If that is the case then the market is in a new bear cycle and the bottom last week is not the final low.
Nonetheless, the market can go higher from here for the rest of this month. If the market pulls back towards last week's low and holds it then it will be setup to rally back up for the next few weeks. Gold stocks would then break out of their recent resistance areas and rally to new 52-week highs by the end of this year or early January.
If we do get such a rally the action in the market is likely to be similar to what we saw at the end of August and early September after the market bottomed. I would expect to see the S&P 500 pull back down to around 1430-1450 in the next few days and then go back up to its 1480-1490 resistance area. It would then likely pause for a week or two and then breakout in the second half of December. I would then expect it to rally up the 1530-1540 area, which will likely mark a new important top.
If the S&P 500 closes above 1490 in the next few weeks you can expect to see the 1530-1540 area act as key resistance. This is the level of the July high. If the market were to get to that level I would expect to see a large correction occur afterwards - one that would likely take out the August lows. What you would witness then is the completion of a five months head and shoulders pattern.
Bottom line is that recent price action suggests that the current rally will continue into the end of the year. However, sentiment and long-term indicators such as the advance/decline line and sector leadership patterns - or lack thereof - suggest that the market is in the process of entering a bear market. If this is indeed the case then you can expect the market to rally through this year, and possibly into the middle of January and then fall completely apart once that rally ends.
The trading action this week will be key. If the market averages close below their lows of last week, then all bets are off and we'll see a real panic washout that will lead to a true bottom. Otherwise you can expect some backfilling for the next week or two and then a rally into the end of the year. That rally will mean profits will be made over the short-term going long and then next month at some point by taking short positions against the market.
For the long side gold stocks are once again about to shine.
The XAU and HUI mining stock indices have been trading sideways for the past week and a half. On Friday it appeared that they were going to head down towards their recent lows - and possibly break them this week. Key support on the HUI is at 400. If the HUI holds this level for the next few days then gold stocks will break out of their consolidation patterns to the upside by the end of the week. However, if the HUI closes below 400 then a deeper correction will come first.
It all depends on how far off last week's highs the broad market drops. If the broad market is going to rally into the end of the year then gold stocks are unlikely to fall below support. In fact you can expect them to start to outperform the broad market again before the week is over and break through their 52-week highs in January at the latest.
I'll be watching the action very carefully over the next few days. If I like what I see I'll once again be recommending a basket of gold stocks to hold for an end of the year rally. A rally for the XAU from here to its high would be a 14% move and the right gold stocks will move twice that much. That's not bad for an end of the year rally.
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