Did We Miss A Major Gold Low? GLD Option Traders Were Near-Record Bearish

Has gold already bottomed? Did we miss a great buying opportunity or will there be a better one ahead? Here is a look at three indicators (along with charts) that help narrow down the next best entry point.

Following gold’s record setting decline, gold prices have rallied 10% and the (gold) dust is starting to settle. Does that mean the bottom is in for gold?

Demand For Gold Coins at Record High

The drop in gold prices was viewed as a buying opportunity by gold coin investors. The United States Mint sold a record 208,500 ounces of gold coins in April 2013 (data as of April 29). The only month investors bought more gold coins was in December 2009.

Gold prices and the SPDR Gold Shares (GLD) dipped a bit lower in January and February and soared thereafter (see chart).

GLD Option Volatility Soared at Recent Low

A few years back the CBOE launched the CBOE Gold ETF Volatility Index (GVZ). GVZ measures the market’s expectation of 30-day volatility of gold prices by applying the VIX methodology to options on SPDR Gold Shares (GLD). GVZ works like a VIX for GLD.

When the VIX soars, stocks usually find a bottom. When GVZ soars, the Gold ETF usually finds a bottom. In mid-April GVZ spiked to the highest level since gold’s 2011 meltdown.

This kind of volatility event tends to shake out a ton of ‘weak hands,’ but doesn’t always punctuate the final low. The red circles in the chart below illustrate that lasting lows frequently take the shape of a double bottom.

Up Against Resistance With Only a Minor Bullish RSI Divergence

Lasting price lows usually coincide with waning selling pressure. This creates a bullish RSI divergence (price makes a new low, RSI doesn’t). Ideally there should be a few days in between the RSI and the actual price low.

At the April 16 low for gold, there was a small RSI divergence (one day difference between price and RSI low). Such small divergences can lead to larger scale lows (one example is the March low in 30-year Treasuries), but the absence of a clearly visible RSI divergence generally results in a price relapse and double bottom.

The bar chart below shows gold prices in relation to RSI and various support/resistance levels monitored by the Profit Radar Report. Gold prices are currently pressing against triple resistance.

Sustained trade above resistance would suggest that gold is ready to rally further. Another dip to or towards new lows, however, would provide a much more attractive buying opportunity.

Weekly ETF SPY: XLP – What Defensive Sector Outperformance Means

The defensive consumer staples sector has been outperforming the economically sensitive consumer discretionary sector. Some say that’s bearish, contrarians may say it’s bullish. Here’s what the facts say:

Defensive sectors like health care, consumer staples and utilities have been on fire. In fact, health care and consumer staples are the two best performing industry sectors of the U.S. stock market.

On paper, the strong showing of defensive sectors parallel to all-time stock market highs is odd. But let’s face it; the overall market action (meaning the QE bull market) is odd.

Defensive sector outperformance may be a reflection of investor suspicion. After all, owning defensive sectors is one way to ‘throw your hat in the ring’ without actually going all in.

To what extent are defensive sectors currently outperforming economically sensitive sectors?

The lower portion of the chart below shows the ratio of Consumer Staples Select Sector SPDR (XLP) to Consumer Discretionary Select Sector SPDR (XLY). The XLP/XLY ratio is plotted against the S&P 500 (SPY).

We see that extreme XLP outperformance (red lines) in the mid-2000s either held back the S&P or led to a major market top. Extreme under performance (green line) was generally seen towards meaningful market lows.

Currently the XLP/XLY is more or less in neutral territory.

The second chart shows XLP’s 48.62% rally from the August 2011 low (since its corresponding October 2011 low the S&P 500 gained 47.63%).

XLP nearly touched resistance going back to that low, but is trading above short-term trend line support. The behavior of RSI suggests a tired up trend. A close below green support would be the first sign of a correction. A close above the red line would likely reinvigorate consumer staples stocks.

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Bullish vs Bearish Indicators – Who Has the Upper Hand?

Recent articles highlighted various individual indicators. Some were bullish, but the majority was bearish. This article reviews previously discussed signals and boils them down to one outlook.

In recent weeks we’ve examined various indicators, studies, gauges and seasonality. Some bullish, some bearish. But what is the balance? Does the weight of evidence suggest higher or lower prices?

Listed below is a summary of articles designed to help form an educated and balanced opinion. Articles are categorized as bullish or bearish based on their implications. >> click here to view all the links to prior articles.

Bearish:

April 23: Dow 16,000! Headline Indicator Sways Into Bearish Territory
Barron’s Big Money Poll delivered the most notable sentiment extreme in 2013. Professional investors’ record bullish outlook is bearish for stocks.

April 17: Did ‘Sell in May and Go Away’ Arrive Early?
Based on consistent seasonality, the March 31, Profit Radar Report suspected a mid-April and May double top. The mid-April high is in and the ‘double top’ appears to be in the making.

April 16: From Gold Glitter to Jitter: An Explanation for Gold’s Historic Decline
Falling precious metals prices often foreshadow weakness for stocks.

April 10: Bearish Buying Climaxes are Adding Up for Stocks and Even the S&P 500
Buying climaxes are a sign of distribution, which is bearish for stocks. Discussed in detail was a buying climax in particular for the S&P 500. The most likely outcome was a delayed (1-2 weeks) decline, which is what occurred.

April 4: Yield Spread Between Junk Bonds and Treasury Bonds Hits Alarming Level
The ‘risk on’ trade has reached a level that’s caused trouble in the past.

April 1: AAPL, GOOG, AMZN and MSFT – Tech Sector Giants Turn Laggards
The lagging behavior and lack of leadership by ‘Big Tech’ suggested that the rally is starting to run out of steam.

Bullish/Neutral:

April 17, Profit Radar Report: “There are open chart gaps at 2,850 for the Nasdaq-100 (and 1,588 for the S&P 500). In recent years all chart gaps have acted as magnet and the Nasdaq-100 (and S&P 500) should come back to close those gaps. We’ll close our short positions at 2,740 – 2700 (and around S&P 1,540).”

April 19: Weekly ETF SPY: Russell 2000 ETF – IWM
The Russell 2000 and S&P 500 bounced off major support. That’s bullish … as long as support holds.

April 17: Despite Extreme VIX Movements, Option Traders are ‘Lukewarm’
Option trader sentiment has established a solid track record as contrarian indicator. Contrary to the deeply complacent readings of the VIX, other option-based indicators (like the SKEW index) aren’t even close to bullish extremes.

April 11: Retail Investors Turn Record Bearish as S&P 500 Climbs to All-time High
The most volatile of sentiment gauges fell to a bearish extreme. Viewed in isolation that’s bullish for stocks, but only viewed in isolation.

The April 17 VIX/SKEW article summarized the overall situation as follows:
“To an extent, option-trader sentiment is in conflict with other bearish sentiment extremes discussed recently. When sentiment indicators conflict, technical analysis and support/resistance levels become even more valuable.”

Technicals highlighted key resistance at 1,593 and key support at 1,538. As per the Profit Radar Report, we went short the S&P 500 once the S&P 500 dropped back below 1,590 (April 12) and covered our short positions at 1,540 and 1,562 (April 18 and April 22).

Based on the weight of evidence, there will be a short windon with a low-risk opportunity to go short.

How to go short with minimal risk is revealed in the Profit Radar Report.

Dow 16,000! Headline Indicator Sways Into Bearish Territory

Is Dow 16,000 possible. Sure. It’s less than 8% away from the April all-time Dow high. But, the mere fact that Dow 16,000 is predicted by one of the most followed money polls, suggests that (best case scenario) getting there won’t be easy.

How do fish get caught? They open their mouth. How do investors get hosed? They follow the crowd.

This rather reliable rule of thumb (don’t follow the crowd) has been distorted by the Fed’s quantitative easing. Yes, prior to QE, investor sentiment used to be a rather reliable contrarian indicator.

Nowadays some sentiment indicators have to be taken with a grain of salt and subjected to additional scrutiny as the Fed has taken the edge off extreme readings and their contrarian implications.

Personally, I like to take a look at the composite sentiment picture made up of sentiment polls, money flows and my own personal headline assessment.

My headline assessment includes projections like last weekend’s Barron’s “Dow 16,000” cover. Here’s what Barron’s wrote:

The stock market isn’t the only thing that has set records this spring. Barron’s semiannual Big Money poll of professional investors also is setting a record — for bullishness, that is. In our latest survey, 74% of money managers identify themselves as bullish or very bullish about the prospects for U.S. stocks — an all-time high for Big Money, going back more than 20 years. What’s more, about a third of managers expect the Dow Jones industrials to scale the 16,000 level by the middle of next year.”

Barron’s publishes a magazine to make money and to make money you need to write about stuff people like to read. Bullish news does the trick right now. This suggests that a great many of investors are back into stocks, now hoping for higher prices and looking for ‘evidence’ confirming their bias.

That’s not good news for the bulls. In all fairness, it has to be said that Barron’s has gotten their forecasts right a few times recently.

In October 2012, Barron’s predicted new highs and the February 9, 2013 front cover shouted: “Stock Alert! Get ready for a record on the Dow,” and rubbed in the four words every investor likes to read. “We told you so,” and continued: “In October, we predicted the Dow would pass its 14,165 record by early this year. Now we’re just 1% short. Expect a breakthrough soon.”

But Barron’s had its ‘prime contrarian indicator moments,’ such as: “Is $5000/ounce the new target in gold’s run?” in August 2011 or its ueber bullish 2007 big money poll.

It has to be noted that despite bullish sentiment poll results earlier this year, the media was extremely bearish. The March 10, 2013 Profit Radar Report commented as follows on the lack of media enthusiasm:

The Dow surpassed its 2007 high and set a new all-time high last week, but investors seem to embrace this rally only begrudgingly and the media is quick to point out the ‘elephant in the room’ – stocks are only up because of the Fed. Below are a few of last week’s headlines:

CNBC: Dow Breaks Record, But Party Unlikely To Last
Washington Post: Dow Hits Record High As Markets Are Undaunted By Tepid Economic Growth, Political Gridlock
The Atlantic: This Is America, Now: The Dow Hits A Record High With Household Income At A Decade Low
CNNMoney: Dow Record? Who Cares? Economy Still Stinks
Reuters: Dow Surges To New Closing High On Economy, Fed’s Help

We know this is a phony rally, but so does everyone else. We know this will probably end badly eventually, but so does everyone else. The market likes to fool as many as possible and it seems that overall further gains would befuddle the greater number. Excessive optimism was worked off by the February correction. Sentiment allows for further gains.”

From March 11 – April 11 the S&P 500 gained another 46 points. By April 11, the media started to embrace the idea of rising prices more fully:

Bloomberg: S&P 500 climbs to record on stimulus, earnings optimism
Reuters: Dow, S&P close at record highs in broad rally

In my admittedly unscientific estimation of headline sentiment, the media is still not as enthusiastic as it was in late 2010 or prior to the 2000 or 2007 highs.

Barron’s Big Money Poll results are nevertheless concerning and combined with weak seasonality, waning market breadth will probably lead to lower prices.

Dow 16,000 later on in 2013 doesn’t seem so far fetched though. Don’t get me wrong, now is not the time to be short (we went short at S&P 1,590), but I wouldn’t write off Dow 16,000 unless key support is broken.

Weekly ETF SPY: Russell 2000 ETF – IWM

Risk is rising when leaders turn into laggards. After outperforming the S&P 500 for years, the Russell 2000 failed to confirm the S&P’s new all-time high on April 10. The stock market in general peaked the next day. Here’s an updated look at the Russell 2000 and the Russell 2000 ETF.

We’ve been using the Russell 2000 Index as a ‘thermometer’ to see if the market is getting overheated. How can any one index work as a thermometer?

As rallies or bull markets mature, investors typically find fewer and fewer stocks at a price tag that justifies buying. Mature rallies are therefore accompanied by selective buying.

Selective buying is just a fancy expression for some indexes beginning to lag and underperform. High beta indexes, like small caps, are usually the first to be left in the dust.

That’s exactly what happened in early April, particularly on April 10. The S&P 500 rallied to new all-time highs. The Russell 2000 did not.

The April 10, Profit Radar Report pointed out just that: “The stock market has arrived at a point where selective buying is cautioning of a looming high. Upcoming resistance levels and divergence spreads (i.e. Nasdaq-100 compared to Nasdaq Composite, DJIA compared to DJA, and S&P 500 compared to Russell 2000) provide a low-risk opportunity to go short.”

In other words, there is a low-risk opportunity to go short as long as the Russell 2000 remains below its all-time high (recorded on March 15).

The purple bar in the chart below highlights the difference between the April 10 and March 15 highs, seven points. The risk of going short on April 11 was seven points. So far the Russell 2000 has fallen as much as 48 points. This is a risk/reward ratio of almost 7:1 in your favor.

On Thursday the Russell 2000 closed right above important triple support. Although RSI (bottom of chart) did not yet confirm the new price low, it failed to provide an obvious bullish RSI divergence. This suggests that any bounce at current support will lead to at least one more leg down.

A move below 890 should minimally lead to a test of 868, possibly lower.

The second chart shows the same support levels for the iShares Russell 2000 Index ETF (IWM). IWM already closed below the two ascending trend lines. Once price drops below support it turns into resistance (that’s why the trend lines are colored red).

IWM may foreshadow what’s next for the Russell 2000, but when it comes to trading/investing, I base my technical analysis on the purest representation of the respective asset. The purest representation of the Russell 2000 is the Russell 2000 Index, not the Russell 2000 ETF.

Nutshell summary for IWM: Based on trend line support for the Russell 2000 Index, small caps are likely to find support around current prices, but should ultimately move lower before embarking on a more sizeable rally again.

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April 12: GDX broke through support with a vengeance. A new low is likely before we’ll see a significant rally.

April 5: XRT closed below trend line support and registered a failed bullish percentR low-risk entry (lingo for: the up trend is likely broken). XRT is still trading above support at 68.70.

March 22: AAPL’s break above trend channel was a fake out break out. The March 31, Profit Radar Report stated that: “Apple failed to bounce from parallel channel support (on the log scale chart) and closed below. Our stop-loss was triggered and the option of much lower prices is now on the table. I’d like to see further confirmation, but the potential target for Apple may be as low as 353. Support at 425 – 405 could soften or halt the decline.”

March 15: XLF trades as high as 14.65, which was right in the 18.52 – 19.66 resistance cluster that was likely to halt XLF’s rally.

March 7: The Nasdaq-100 (corresponding ETF: QQQ) had two open chart gaps: 2,806 and 2,860. Although it seemed unlikely at the time, the Nasdaq-100 closed the gap at 2,860 on April 10 before declining well over 100 points.

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Did ‘Sell in May and Go Away’ Arrive Early?

When you look at this chart you’ll inevitably say: “Why didn’t I think of that?” Sell in May and go away worked for five years in a row. But when it’s too obvious, it must be wrong, right? Here are the S&P 500 trigger levels that suggest seasonal May weakness arrived early this year.

Below is a detailed analysis of the bearish April/May seasonality originally published by the Profit Radar Report on March 31, 2013.

Forecast for the month ahead: Investors Business Daily just inquired about my 2nd quarter ETF pick. I expect the 2nd quarter to be a tale of two markets, so coming up with one pick was a tough assignment. Click here to read the Investors Business Daily write up.

Why a tale of two markets? The chart below highlights a pattern that played out in 2008, 2010, 2011 and 2012. The S&P 500 sprinted into an April/May high and collapsed thereafter.

The table below captures more pattern details, such as the May 1 (or closest trading day) high, Q2 high, subsequent low and the May 1 to subsequent low loss.

Unfortunately, I’m not the only one to pick up on this pattern. The ‘sell in May and go away’ phrase is already making its rounds. Anytime a certain pattern or reaction is too widely recognized, there’s reason to be suspicious. I’m not suspicious enough to disregard the pattern, but we will use trigger levels to identify low-risk entry levels.

Here are two character traits that may help us authenticate the developing pattern:

1) The May high usually occurs quickly. There’s a spike higher followed by a quick decline. A slow top (several consecutive dojis) or failure to decline would caution that the pattern will delay or not show.

2) A deep retracement following the initial top and decline may form a double top. We saw this in 2012 (see first chart) and I wouldn’t be surprised to see a mid-April high followed by a secondary May high.

The upcoming Profit Radar Reports will deal with any possible changes to the pattern, but for now we expect stocks to maintain a bid for at least the first week of April and rally deeper into the resistance range/target at 1,576 – 1,593 (red lines on chart).

Since the market has blown past previous resistance areas, we will wait for one of the following triggers before going short:

1) A move above 1,577 followed by a close below 1,576.

2) A move to 1,590 (stop-loss around 1,610).”

So far the S&P’s price action has meet all the qualifications needed to authenticate the ‘sell in May, go away’ pattern. It does appear that the bearish pattern arrived early.

However, the May top has a tendency to appear as a double top, so it’s quite reasonable to expect another assault on the April 11 high over the coming weeks.

Despite Extreme VIX Movements, Option Traders are ‘Lukewarm’

According to the VIX, option-traders are complacent and have been complacent for many months. The bearish VIX implications however, have not been confirmed by two historically accurate options-based sentiment indicators.

The VIX soared 43% on Monday, collapsed 19% on Tuesday and is up nearly 30% today. Just before that, the VIX fell to the lowest reading since February 2007.

Although the CBOE Volatility Index (VIX) is rushing from one extreme to the next, options traders as a whole have been remarkably ‘non-committal’ or lukewarm from a sentiment point of view.

This sentiment deviation is illustrated by the chart below. The CBOE Equity Put/Call Ratio has been narrowing in a triangle shape formation void of extremes. The 2010, 2011 and 2012 market highs were preceded by at least one daily reading below 0.5 and a drop of the 10-day SMA below or at least close to 0.55.

The 2013 Equity Put/Call Ratio low was at 0.54 on March 6 (the 10-SMA has yet to fall below 0.6). The recent all-time highs caused no put/call sentiment extremes.

Quite to the contrary, the VIX has rushed from one extreme to the next. For that reason, the Profit Radar Report noted back in November that the: “VIX has been of no use as a contrarian indicator and will be put on ‘probation’ until it proves its worth again.” Yes, the VIX is still on probation.

A SKEWed Market?

The CBOE publishes another options-based index like the VIX, it’s called the CBOE SKEW Index. The SKEW in essence estimates the probability of a large decline.

Readings of 135+ suggest a 12% chance of a large decline (two standard deviations). A reading of 115 or less suggests a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

The chart below juxtaposes the SKEW against the S&P 500. Last week the SKEW fell as low as 117. This was odd as readings below 115 (dashed green line) are generally bullish for stocks.

Conclusion

The CBOE Equity Put/Call Ratio and SKEW index proved to be valuable contrarian indicators in 2010, 2011 and 2012. The current option-trader sentiment is not bullish, but it’s not as bearish as one would expect to see at a major market top.

To an extent, option-trader sentiment is in conflict with other bearish sentiment extremes discussed recently. When sentiment indicators conflict, technical analysis and support/resistance levels become even more valuable.

The April 10, Profit Radar Report highlighted key resistance at 1,593 and stated that: “A move above 1,593 followed by a move back below 1,590 will be a sell (as in go short) signal.”

As long as prices remain below key resistance, the trend is down until stocks find key support.