The Gilmo Report

April 24, 2011

April 24, 2011

Given that it is only one trading day since my last report of this past Wednesday, not too much has changed aside from the fact that the NASDAQ Composite Index staged a reasonable gap-up and trendline breakout on Thursday, along with several other major market indexes, as we see from its daily chart below. While some might fret over the lighter volume, keep in mind that volume might be expected to be somewhat muted given the three-day Easter weekend holiday. What is most amazing about this chart is the three-day upside blitz and recovery off the lows of this past Monday after Standard & Poor’s downgraded the U.S. credit-watch to “negative.” I can just hear Darth Vader exclaiming, “Do not underestimate the power of The QE2 Force!”

NASDAQ Composite Index Gilmo Report Chart

I have to admit it’s been a while since I’ve had any position double since first initiating it, but that’s exactly what the ProShares Ultra Silver 2-times leveraged ETF (AGQ) has done for me since the initial entry on the breakout through 160, corresponding to silver futures breaking out through about $31.50 in mid-February. Unfortunately I should have mortgaged my house and other property and plowed all that into it as well! So much for 20/20 hindsight! J I’m not aware of any stocks that have doubled in two months, hence I have not found much reason to sit in anything else but silver, something that attests to the unusual environment we are in these days. In my view we may be getting close to a climax type of move here that may take silver up to the $50 level, my upside target since silver was in the 20’s and as is well-documented on Fox Business News videos. I am watching here for a big upside day, perhaps 30-40 points or more, in the AGQ as a sign of an intermediate top as interest in the white metal reaches a fever pitch.

ProShares Ultra Silver 2-times leveraged ETF (AGQ) Gilmo Report Chart

To get a sense of how silver might form an intermediate top, since I do believe that silver will eventually go much higher than $50-an-ounce, it is helpful to go back to 2006, when silver futures had their last clean, parabolic upside move. In one of its first “catch up” moves to gold, silver began a sharp upside rally in early 2006 that culminated in nine straight up days where the final day up showed a bit of “stretching” as it was the largest point move in the entire run coming up through the $8 price level and as high as $15. Note how silver broke down sharply from the peak before turning right back up to new highs and completing a double-top formation. Silver then went on to build a longer consolidation, and the last place that I bought physical silver was around $16 as silver was coming up out of a long consolidation in 2009, three years later. Thus the chart below may provide something of a “road map” for handling silver today, as it certainly illustrates why one should begin to look at being a seller into a climactic type of run in the white metal, no matter how alluring it might look.

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Since the chart from 2006 is of the nearest silver futures contract, and the first chart was of AGQ, a 2-times leveraged silver ETF, it may also be useful to compare apples to apples by looking at today’s nearest silver futures contract in contrast to the 2006 chart. Both of these are daily charts, and we can see that each of the moves to new highs over the past seven days have shown at least a little bit of selling into the move as well as the inherent intra-day volatility in silver. Monday of this past week was a good example as the precious metals initially rallied sharply on the Standard & Poor’s U.S. credit-watch downgrade, then sold off on the thinking that this might lead to higher interest rates (good for the dollar, bad for commodities, theoretically), before finally rallying again and closing just under $43. If we are looking for some sort of climactic move, then we must absolutely keep an eye on the futures as we could also simply have a nice 3-5% pullback that leads to a short consolidation. The bottom line is that we should simply be aware of the potential for a climactic, intermediate-term top so we can identify it when we see it. I don’t think we’ve seen it just yet.

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As we know from numerous discussions in previous reports, gold is just a few days beyond a nice breakout from a longer-term consolidation. Gold has risen over 5½-fold from its 1999 lows of $268, while silver has risen over 10-fold off of its 2000 lows of $4.07. A daily chart of the PowerShares Gold Double Long (DGP) ETF, below, shows the breakout through the 44 level, in early April. DGP then pulled back one time before launching higher. Right now it is sitting at 47.22, corresponding to a gold futures price of $1505-an-ounce and 7.3% past the 44 buy point. Right now you are looking for a pullback in gold as a buying opportunity because the ETF is somewhat extended, unless you are able to buy here and withstand a possible 7-8% pullback. I tend to think that gold is just getting going here, and while the road is always volatile when it comes to precious metals and other commodities, my near-term target for gold is $1700, using the $1450 level as my downside selling guide in case I’m wrong.

PowerShares Gold Double Long (DGP) ETF Gilmo Report Chart

The driver in commodities and in particularly the precious metals has been the continued downtrend of the U.S. Dollar, for which I show a weekly chart of the U.S. Dollar Index, below. Interestingly, if I want to remain fully objective here, there are two ways to look at this currently on the weekly time frame. First of all the dollar has just undercut the 2009 lows at 74.17 – does this mean we are headed towards the 2008 lows where the dollar dipped below the 71 level? Or on the other hand does this set up the potential for a little undercut & rally type of action on a double-bottom type of set-up? It doesn’t mean the dollar has to turn and begin a grand uptrend, but a reaction rally from here on the weekly chart is a possibility. On the third hand, is the U.S. budget deficit situation so bleak such that politicians in Congress will simply vote to raise the budget limit, which I think is likely, and continue to go with the momentum of continued borrowing and attempting to inflate their way out of the situation? If this is the case, then the dollar will be the “tell” if it continues to press for the lows of 2008. Watch the action here carefully.

U.S. Dollar Index Gilmo Report Chart

Individual stocks present something of a mixed back, and even the action in Apple, Inc. (AAPL) leave something to be desired. AAPL came out on Wednesday after the close and blew away earnings, sending the stock up about 4% on Thursday. Technically, as the daily chart below shows, we might consider Thursday’s move as a pocket pivot type of move: Volume was higher than any down-volume day over the prior 10 trading days and the stock was able to move above its 50-day moving average. However, the fly in the ointment here is the fact that the stock has essentially come straight up off the bottom of its base in a somewhat v-shaped formation instead of a coherent, “quiet,” and constructive sideways movement preceding the pocket pivot type move. Adding even more confusion to the mix is the fact that AAPL’s move could also be seen as a buyable gap-up, given that volume was 1.53 times average and the gap move was at least .75 times the 40-day Average True Range (see April 20th report) with the idea of using the 50-day line at around 345 as a selling guide.

Apple, Inc. (AAPL) Gilmo Report Chart

There has been some resurgence in technology stocks, and Cypress Semiconductor Corp. (CY) threw its hat into the ring on Thursday after announcing earnings and staging a valid pocket pivot buy point as it came up through its 50-day moving average. CY makes a range of different types of semiconductors, including those used in touch-screen technology, and the past four quarters have seen a big turnaround in earnings growth, while sales only grew 15.2% in the most recent quarter. The data portion of the daily chart, below, which is based on Reuters data, shows big estimates for the next two quarters, which differs from other sources I’ve looked at, but the key thing to watch here is the technical action. The Philadelphia Semiconductor Index, also known as the SOX, has been lagging the market on this most recent recovery off the mid-March lows but over the past two days has surged higher on the backs of stocks like CY. If the technical action in CY is one clue that the SOX is going to get back into synch with the market as it did in November and December after lagging throughout September and October 2010, then this pocket pivot buy point should work with the idea that it will hold the 50-day line at around 20.

Cypress Semiconductor Corp. (CY) Gilmo Report Chart

JDS Uniphase Corp. (JDSU) is a big name in optical networks that corrected well over 30% off its peak after Finisar (FNSR) blew to pieces following its earnings announcement in early March. While FNSR looks much weaker, I do not see that this is necessarily the case with JDSU. I’ve been keeping an eye on JDSU since it still maintains a 92 EPS rating and a 92 Relative Strength rating, which you may find to be somewhat bizarre given that it is still 31% off of its peak. A sign of the times, I suppose, but note on the daily chart below that JDSU has come all the way down to completely fill the “rising window” from the big gap-up move in early February and find support right at the lows of the rising window. The stock has managed to put in a pocket pivot volume signature here as it rallies above its 65-day exponential moving average with earnings coming out in early May. JDSU is looking to come in with big earnings growth in the next quarter and I have to wonder whether the stock will see a move similar to CY, above, after it announces earnings. Not your orthodox buy situation, but something interesting to keep an eye on going into earnings.

JDS Uniphase Corp. (JDSU) Gilmo Report Chart

Netflix, Inc. (NFLX) has done pretty much what I expected it to do, which is build a handle over the past 2-3 weeks to finish out a relatively short cup-with-hande formation. Selling dried up in the extreme on Monday of this past week and so it only took a minor pick-up in buying volume to send the stock to all-time price highs. The only thing problematic with this breakout is the lack of volume, which came in at -8% below average, not what you want to see on an otherwise clean breakout to new highs. Another sign of the times, I suppose, but NFLX announces earnings on Monday after the close with estimates of 81-83% earnings growth, depending on what data source you are referencing, on $1.08 per share. NFLX has a B+ accumulation/distribution rating and its RS line has confirmed the move to new highs, which may help to make up for the lack of upside volume on Thursday’s breakout, but the key event will be Monday’s earnings. NFLX will likely be the stock to watch on Monday.

Netflix, Inc. (NFLX) Gilmo Report Chart

Chipotle Mexican Grill, Inc. (CMG) came out with earnings on Wednesday after the close and the stock dropped about 10 points, but by Thursday was finding some support around its 20-day moving average (green line), as we see in the daily chart below. CMG was helped out by the fact that it is being added to the S&P 500 Index, and the stock was able to hold its recent breakout through the 275 price level. Earnings growth begins to slow up over the next two quarters, but I have to think that the market already knows this. Thus the critical factor is the “new product” variable in the equation with CMG’s newly announced line of Asian cuisine restaurants, ShopHouse Southeast Asian Kitchen. If the company is as successful with this new line of restaurants as they have been with their Mexican-themed restaurants, then they could easily see another boost in earnings growth. Hence the technical action is your first clue here, and the fact that the stock was able to hold its prior breakout at the 275 level on Thursday after selling off after-hours on Wednesday appears constructive, and the stock is currently at a potentially buyable level right here at the prior breakout buy point.

Chipotle Mexican Grill, Inc. (CMG) Gilmo Report Chart

Lululemon Athletica, Inc. (LULU) has been a monster of a stock as it has continued to run higher, clearing the $100 price level this week. The company doesn’t announce earnings until June, so right now that is not a factor, but this move above the “century mark” may now invoke Livermore’s rule whereby a stock that is breaking out through a big round “century mark” number like 100, 200, 300, etc. should continue to move through that price level with some upside thrust. You can read more about this Livermore rule in my August 18, 2010 report, but the basic idea as Livermore put it is that a stock clearing such a level should move well past the level in short order. Thus Livermore might look at LULU as being very buyable as it comes up through the $100 price level with the idea of using the $100 level as a downside stop, allowing perhaps for a little “porosity” around the 100 level as the stock works its way past what can also be a psychological resistance level given the big round number. Once that psychological resistance is cleared, however, the stock may move rapidly to 110, as Livermore postulated.

Lululemon Athletica, Inc. (LULU) Gilmo Report Chart

I last discussed rare-earth metals miner Molycorp Inc. (MCP) as it was moving up through the 50-day moving average in mid-March on a “bottom-fish” type of pocket pivot buy point and then again once the stock had broken out through the 62.80 high in this square-looking cup base. Now, as we can see in the daily chart below, MCP is pulling back significantly for the first time since its pocket pivot buy point in mid-March, and I would look to buy the stock as it approaches the breakout level around 62-63. MCP has come straight up off the bottom of this recent base, so it is entitled to a nice pullback here, but I might consider such a pullback to be quite buyable if it is relatively well contained. And by that I mean pulling down no further than the yellow-highlighted area I’ve drawn on the chart, although it is possible that the stock could find support at the 20-day moving average just above the 65 price level. MCP is finally expected to make some money two quarters from now, but note how sales are starting to ramp up sharply.

For now my buy zone on any pullback might be 62.80 to 65.80, with the understanding that the stock could pull down as far as 60.

Molycorp Inc. (MCP) Gilmo Report Chart

The sharp three-day move off the lows of Monday shows how dangerous this market can be for eager shorts, thus it appears for now that the long side presents the best opportunities for profits. Silver has been the story to focus on, and the clean trends in the SLV or the AGQ more than make up for all the choppiness in individual stocks, at least from my perspective. The stocks I’ve discussed in the past four reports are all still in play, and members should refer to those reports as my discussions on several retail leaders, tech stocks, and medical/bio-techs in those reports still stand. Fed Chairman Ben Bernanke will be speaking next week, and the market may gain some insights into the fate of QE2 and the potential for QE3. I would not try to predict what will come out of any of this, as it is simply not possible to predict the news, much less how the market will react to any particularly news item. Case in point: the Standard & Poor’s downgrade of the U.S. credit-watch to “negative.” If we had known that this would occur in advance, would we have known that it would lead to a panic low and a subsequent, sharp market rally? For now the indexes are breaking out and leading stocks are continuing to act well, with cloud-computing, semiconductors, and software remaining strong areas in technology that are, as in the case of the cloud stocks like VMW and CRM, showing some resurgence. Bottom line: The market uptrend remains intact for now, and so that is how we will continue to play it while remaining selective and taking each stock on the basis of its individual merits and technical action.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held positions in AGQ, DGP, GLD, and VMW, though positions are subject to change at any time and without notice.

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