Market Poised to Test August Lows


By Mike Swanson

Jan 16 2008 10:33AM


Yesterday was another big downer for stock bulls as the broad market averages all gapped down on the open and fell hard into the close, with the DOW falling to the 12,501 level and the Nasdaq dropping 60 points. This morning market futures are deeply in the red again on the backs of a 14% plunge in Intel's after hours trading in response to disappointing earnings. In an earnings conference call Intel's CEO said he saw no sign of a bottom in the economic slowdown.

The market averages are all likely to open near their August lows this morning. On a strictly momentum basis the market averages are oversold, however on a sentiment basis there is no sign of a bottom. The VIX barely rose during yesterday's drop while the put/call ratio is fairly subdued. The Investors Intelligence numbers still are not in the territory associated with important market bottoms.

My working thesis the past few weeks has been that we would not see a real end to this correction until we saw a panic washout below the August lows that would bring an extreme reading in the sentiment indicators. I still believe this, however, at this point we may easily get a dead cat bounce around the August lows first. That bounce could even last into the end of the month FOMC meeting. If we get a bounce, no matter how long it lasts, I would not view it as an end to this corrective wave and would not look to buy until the sentiment indicators display real bearishness, which they are not. Personally I have no interest in going long on the open in order to game temporary bounces. In bear markets I find it best to stay out of the way until the dust settles. Everyone who has prematurely tried to guess a bottom so far this year has gotten badly hurt. Instead of bouncing the market could just as easily meltdown right now and have a mini-crash bottom like we saw in August, even though I think there is a good chance of a bounce.

This is the first leg down of the bear market. Once it ends with a climatic bottom I expect to see a 4-8 week rally and then another leg down. That rally is worth playing though as it will be similar to the sharp move we saw from August to October. But in the end it will just be a rally too. Do not underestimate the deteriorating economic fundamentals behind this bear market. Yesterday Citigroup wrote off over $10 billion in mortgage bets gone bad. It has more write-offs to go! Instead of just writing off the full amount of their losses in October banks are hiding the full extent of their losses and releasing them to us piecemeal. This prolongs investor pain and this bear market, but gives bank stock insiders more time to unload their shares on to the gullabull public. In bear markets someone is always left holding the bag.

We aren't at an end of the current downleg yet. If the market ends up down huge today then we'll be on bottom watch. But if it bounces today off or around the August lows within the next two trading sessions the ultimate bottom to this downleg will probably be pushed off a few weeks into the future. It will be interesting to see what happens today.

Let's turn to gold stocks. So far this year gold stocks have been the strongest thing in the market. Besides gold and silver stocks agriculture stocks have been practically the ONLY thing going up. Other metals stocks have been dropping this year and oil and energy stocks have been weak too. The commodities sector has been rolling over and showing signs of being ready to correct. Yesterday gold stocks showed their first real weakness since their bottom in December. The XAU and HUI indices have rallied so hard and quickly that they have become overbought on all daily momentum indicators, such as the stochastics, which I've circled in the above chart. Yesterday the XAU/gold and HUI/gold relative strength ratios broke their upward trendlines. When they did this in November they gave a sell signal. I take yesterday's action as a sell signal too. A correction in gold stocks from here is EXTREMELY likely.

If gold stocks correct I have 445 and then 431 as the initial support levels for the HUI. These are the 1/3 and 1/2 retracement levels of the recent rallies. During corrections in intermediate-term uptrends though gold stocks tend to fall down toward their 50-day moving averages, which is around 420 on the HUI. So I think the odds favor a bottom in the 420-431 range.

Such a correction would coincide with further weakness in the broad market - and once this correction in the broad market ends and the market rallies I expect gold stocks to lead. From the next bottom pivot point in gold stocks I see another 30-40% rally occurring so this is going to end up being a huge buy opportunity in gold and silver stocks. Long-term investors shouldn't worry about a potential dip here, but simply hang on.

We called the top in the broad market in October and the top in December. We're on top of this market. If you know anyone else who is let me know. It is time for you to prepare for a buy point in mining stocks over the next few weeks. Sign up for our free gold stocks newsletter.  Just click here.  

Michael Swanson


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