Still like gold

What an ugly day!  Huge morning gap lower followed up by additional selling into the close.  Hope you remain hedged and the day wasn't too painful.

We've been bullish on gold ever since the high volume breakout last September.  Recently gold has grabbed our attention again, though this time for bad behavior.  Normally when a stock hits fresh highs you expect to see follow through.  If you don't see follow through, at the least you expect the stock to hold onto its recent gains.  Gold hasn't been doing this.  Instead, gold repeatedly hit new highs only to give them up (and then some) in the days after.

At first we planned to scold gold and warn readers of a possible selloff.  After further research however, we've changed our mind.  Instead we're praising gold once again.

Gold is a safe haven against inflation, not risk.  When investors get spooked and bolt for safe assets, they move to cash and treasuries.  Gold gets lumped in with the rest of the risky bunch.  Given that classification, we have a new found respect for gold's recent behavior.  Sure it's not breaking strongly to new highs, but it's hanging onto high ground just fine despite a major flight-to-safety.  

Notice how gold and the S&P have tracked each other pretty closely since the March lows.  Since May, gold has continued to appreciate while stocks have plummeted.  Meanwhile treasuries have risen sharply.

If the flight-to-safety trade continues much longer, we will likely see gold dip and give up some of it's relative outperformance over stocks.  Watch out when investors' appetite for risk returns though, as gold will quickly return to the champion it's been for the past decade or so.

A breadthless advance

Although the market has recovered -- thanks largely to Thursday's huge rally -- the internals remain ugly.  We hoped we would be comfortable removing the hedge when we pushed above the 111 mark on the SPY but we remain firmly hesitant to do so at this point.

Unlike the previous corrections in this rally, breadth is missing-in-action and makes us question the validity of last week's run.

We like to be aggressively long when the High-Low indicators are on the rise.  The rest of the time it is best to play the market defensively.  

Although price action suggests the hedge should soon be removed, we won't do so until we see at least the beginning of a new uptrend in the point & figure chart of the NYSE BPI (a new column of Xs formed to the right of the current column of Os).  We also want to see the High-Low indicators start climbing again, but we may remove the hedge before then if other breadth indicators strengthen enough to warrant it.

The 200-dma's a bitch

The only thing special about the 200 day moving average is that investors have deemed it special.  Any length near 200 would work fine as a replacement, but why pick something like 217 when you can go with a nice round number like 200?  As more and more investors have gained confidence in the art of technical analysis, the 200dma has gained recognition as the key moving average to reference when looking at long-term trends.  Same goes with the 50 for mid-term, 20 for short-term, and 10 day for tracking the shortest of trends.  

Notice the support and resistance these key moving averages have provided over the past year:

Support and resistance come in many forms, but primarily are found at moving averages and areas of congestion like old highs and old lows.  They affect investor behavior by giving investors reason to hesitate and rethink the latest trend.  

If investors are confident in the direction of the latest trend these key support and resistance levels pose little challenge.  However, if the market reaches these levels while investor uncertainty remains high, they prove difficult to overcome and often require numerous attempts to breakthrough.   

Over the past two weeks the S&P has tested the 200 day moving average multiple times and come up wanting.  We gapped lower, ran higher, and were turned back by the 200.  We gapped higher, ran higher, and were turned back by the 200.  We crossed above, below, above, and below but were never able to follow through on the direction of the latest cross.

At this point however, this back-and-fill action is neither bullish nor bearish.  Simply indecisive and inconclusive.  What's great about the action we've seen over the past two weeks is it has narrowed the key support and resistance levels we need to breach before gaining further insight.  Those levels are 105 on the downside and 111 on the upside for the SPY, between them is no man's land.

If some of your individual positions are taking a beating, don't be too hard on them.  The selling we have seen over the past two months has been very one sided and driven by macro issues.  Just look at the number of 90% down days recently (over 90% of the trading volume for the day was down).  Today was a 99% down day.  Even the best of the best with all the bullish arguments in the world have a hard time standing tall in this type of action:

Continue to remain hedged for now and sit patiently as we await the market's next move.

Ready to run?

Trading action over the past few days was much improved with today's action pushing us to a new two week high.  What we want to know now is whether investors are ready to chase stocks higher once again or whether they are simply done selling for the time being.  

If all we've done over the past month is washout sellers, then we'd like to remain hedged as the upcoming weeks will see a continuation of the recent volatility with little upward progress and the possibility of further downside.  On the other hand, if investors have digested the recent market fears and priced in the negative news, we are likely to see another leg higher without much more consolidation.  

We believe it's a little of both and at this point feel volatility remains too high to comfortably remove the hedge.

When volatility calms down and the market is able to make new highs without quickly giving them back we'll reconsider removing our hedge.  Until we reach that point, continue adding to your stronger positions to ready yourself for the eventual next leg up.  We are pleasantly surprised by the number of stocks still in favorable chart formations despite the broader market woes.  For a list of the ones we remain interested in check out the "pounce" list on our current positions page: http://blog.onislandassetmgmt.com/?action=page&url=positions  

Here are the "pounce" names in alphabetical order as of the close today:

• AAPL
• ACTG
• AMMD
• APKT
• AZO
• CBOU
• CBPO
• CMG
• CRUS
• CSTR
• CTRP
• CVLT
• CWS
• DGIT
• DTPI
• ECPG
• GLD
• HMIN
• IDXX
• IPXL
• LMNX
• MNRO
• NEOG
• NFLX
• NTAP
• OPEN
• PANL
• PPO
• PWER
• SPRD
• SRLS
• SXCI
• THOR
• VRSK
• VSI