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Should You Be Concerned About the Lack of Leadership in Gold and Commodities

By Mike Swanson      Printer Friendly Version
Feb 5 2008 11:27AM

Yesterday the DOW fell over 100 points and the S&P fell 14 as the market has had its first encounter with resistance(the 1/3 retracement level and December lows) since it bottomed the other week. I'm still a believer in this rally despite yesterday's set back and today's opening. Much of the drop yesterday was fueled by banks and brokers downgrading each other.

Today futures are in the red as I write this, with S&P 500 futures down 5. If the market is weak in the first half of the day then its 60 minute stochastics will get oversold. I don't see much more downside if the market falls today.

Yesterday I talked about the sectors that have been leading this rally. Today I want to focus on the sectors lagging, with a close look at gold stocks.

I use TC2007 to study the market and find stocks to buy. TC2007 breaks the market up into 239 sectors so that I can track how the sectors behave relative to the rest of the market and each other. The above is a sort of the performance of the worst performing sectors, with their returns, since January's bottom.

As you can see the stocks in the bottom 9% of performance since the bottom include silver, gold, drugs, and health care stocks. Oil stocks are also lagging, posting a ranking under 30%.

The gold and health care stocks were actually leading the market in the first few weeks of January. Normally in bull markets sectors that lead towards the end of a market decline become leaders on the next rally. But in this bear rally this hasn't been the case, as a lot of beaten down and heavily shorted sectors have been leading. This is classic for bear rallies.

I'm growing more concerned about gold stocks. Last Friday I got stopped out of my gold stock positions, as reported in WSW Power Investor, and today gold is trading under $15 an ounce. Many gold stocks are going to gap down and actually be in the negative from where they opened up at on the January broad market bottom. At the moment gold stocks are very oversold on a 60 minute chart. They also are trading on their lower 10-day bollinger band, which is an important support area. Support on the XAU is currently at 179. If the XAU can close above this level today then gold stocks will be set to bounce over the next week. We should then see the XAU bounce back up to the 188-190 area. However, if the XAU closes below 179 then you can expect a drop to the 170-174 area and then a bounce.

I'm hopeful that gold stocks can bounce here, because the broad market should find a new footing today or tomorrow morning.

I'm long-term bullish on gold stocks, but it appears to me that they are eventually going to get in trouble with the rest of the market. Once this bear rally in the broad market ends I expect gold stocks to correct hard - harder than the rest of the market. I see them falling hard in the spring, and making a new bottom in the summer. At some point gold stocks will break away from the broad market and have a massive rally, but this doesn't look like it is going to happen over the next few months. Perhaps in the Fall or in the 4th quarter, but right now all signs point to them having a big correction in the 2nd quarter.

In the first half of January gold and silver stocks rallied sharply. However, all other commodity stocks dropped. The CRX index, which is heavily weighted by base metal and oil stocks fell while the gold stocks went up and began to underperform the S&P 500 in January.

What this means is that in the commodity complex leadership narrowed to only gold and silver stocks. Gold was the only commodity still making new 52-week highs in January. The other commodities have looked weak for weeks and appear poised to correct over the next few months. If they do it looks like they will take gold and gold stocks down with them for a temporary 3-6 month correction.

At the moment I think the broad market can hold commodities and gold stocks together for the next 4-6 weeks. But once the broad market tops I expect to see a brutal correction in commodities and gold stocks.

The Chinese stock market also appears to have made a major top. Remember back in December how I made note of how the 150 and 200 day moving average begins to slope down when a market makes a major stage three top? Back then I told you how the major US indices were doing this and warning that they were entering bear markets. Now China is doing the same thing. For the past three weeks the Chinese stock market has been lagging the US.

Last year the market was led by commodities, Chinese stocks, and tech stocks such as Google, Yahoo, APPL, and RIMM.

In the past few weeks we have seen major breakdown in the tech stocks that led the rally last year. This month Chinese stocks and commodities stocks have broken down. The sectors that led the market last year are all breaking down and are now lagging during this bear rally. Gold stocks were also leading the market from August to just now. They appear to have lost their leadership and are poised to breakdown in the next 4-6 weeks just as the tech stocks did.

The weakness in Chinese stocks is particularly ominous for gold stocks, because gold stocks have been more closely correlated to Chinese stocks than to the S&P 500 over the past few years. The same can be said about gold stocks and energy stocks.

When you take a look at gold stocks they also are badly lagging the metal. Even though they made new 52-week highs early in January they underperformed the metal when they did so. This is important, because usually the XAU/gold and HUI/gold ratios lead gold and gold stocks. It is bullish when gold stocks outperform gold and when they both go up and gold stocks lag that is a powerful negative divergence that usually spells some sort of top being made.

I do expect the broad market to continue to rally - and expect that rally to keep a bid under gold stocks and commodities. But once the broad market tops, and I expect this to happen in March, I think we will see a big 25-30% correction in commodities and gold stocks. The Chinese stock market is likely to fall 40-60%! If we get such a correction I look to see the XAU bottom in the 130-145 area.

Right now though it has support at 179 and 175. It should put in a bottom there for the next 4-6 weeks. A rally back up to the 190-195 area would be a good place to lighten up on positions.

I know most of you are heavily involved in gold and silver stocks. Take this posting as a warning sign and discussion of what is happening in the market right now. Maybe the underperformance of gold stocks in comparison to the S&P 500 and the gold metal is just a temporary phase. However, if this is continuing into March then you should take action on the warnings in these charts that I'm bringing to you today.

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Michael Swanson



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