The Gilmo Report

April 6, 2011

April 6, 2011

As the market has drifted back up towards its mid-February highs there has not been much in the way of big upside volume. This has the usual feel of what I call “QE drift,” where we see the indexes grind higher on volume that is not heavy, but certainly enough to tip the balance of buyers and sellers in favor of the bulls. But as I wrote over the weekend, with a number of leaders extended to the upside it is not advisable to get overly aggressive on the long side in an effort to chase stocks here. The past four days, as we see on the daily chart of the NASDAQ Composite Index below, have seen the index gap up 3 out of 4 days in a row, only to close below its opening levels on those three gap-up days, which has the look of churning up at the highs here. While we all know QE2 is a random force in this market, the market is clearly in a logical place to pull back, particularly since it has essentially gone straight down and straight back up over the past six weeks, more or less. Thus I retain a cautious posture here, looking to allow leading stocks to pull back and digest some of their recent gains. At the same time, we must remain alert as this move off the lows has been accompanied by little volume, and hence could be vulnerable to something more than just a pullback. Yet more evidence would be necessary to draw that conclusion.

NASDAQ Composite Index Gilmo Report Chart

Netflix, Inc. (NFLX), shown below on a daily chart, illustrates why one does not want to chase leading stocks here. The stock gapped-up this morning en route to what appeared to be a straight-shot to all-time price highs, but by the close staged a big outside reversal day. Some might wonder whether a big outside reversal here is indicative of a “double top,” but that remains to be seen as I would expect the stock to try and build a handle here as it moves sideways roughly within the yellow-highlighted area that I’ve drawn on the chart. Since testing its 50-day moving average three weeks ago, NFLX has marched steadily higher with very little in the way of a pullback, so in my view if the stock is headed much higher, then it must take some time to properly digest its recent price gains. And if this turns into a double top type of formation, then we will know soon enough. But for now we simply observe that the stock is taking what is perhaps a well-deserved rest – for now. As well, you can see that today’s pullback took the stock right back into its 10-day moving average, which could turn out to be a reasonable area of near-term support, although NFLX tends to follow its 50-day moving average, albeit sloppily.

Netflix, Inc. (NFLX) Gilmo Report Chart

Another hot stock that has come straight up off of its lows of three weeks ago is rare-earth metals miner Molycorp, Inc. (MCP). As we see on its daily chart below, the stock got smacked today on a big outside reversal day to the downside on heavy volume. Of course, MCP has come straight up from the bottom, the old “SUFB” flaw that makes it vulnerable to a pullback. As I’ve noted in discussions of MCP in previous reports, this is a big cup formation with absolutely no tight closes in the pattern, hence it looks very loose to me. If one wanted to be paranoid, one could even ask whether this is a cup or some sort of late-stage “Punchbowl of Death.” In my view, today’s action was enough to back away from the stock as I would let it pull back in here to see if it holds the 10-day moving average at 59.75 and the top of this cup-with-no-handle breakout. Technically, there are some clear, potential flaws in MCP’s pattern, and it is necessary to be aware of this fact so that one does not insist on hoping when one should perhaps be fearful. For now, I want to see MCP hold the top of this breakout at around 59-60 and the 10-day moving average.

Molycorp, Inc. (MCP) Gilmo Report Chart

With Congress arguing over exactly what kind of meaningless, pithy cuts they will make to the 2011 budget that sports a record $1.65 trillion budget deficit, the markets are quickly drawing their own conclusions. As I’ve written repeatedly in previous reports, my view is that the U.S. government lacks the will to make any meaningful cuts and instead is faced with a simple choice: default or devalue, which is why I have been bullish on silver and gold. The Barclays 20+ Year Treasury ETF (TLT), shown below on a daily chart, appears to have digested this reality as well, as the TLT is rolling over and down through its 50-day moving average. Bonds are headed down, the dollar is headed down, and interest rates are going to be headed higher – that’s the short answer. What this does to stocks remains to be seen, but these are developments that I don’t find to be constructive, to say the least, for the underlying economy. Last week we heard Walmart (WMT) CEO Michael Duke warn consumers that they had better be prepared for some heavy-duty inflation coming down the tracks. The drop in bonds and the failure of the TLT back down through its 50-day moving average seems to confirm this.

Barclays 20+ Year Treasury ETF (TLT) Gilmo Report Chart

As well, I would expect bonds and the U.S. dollar to move together here as the U.S. grinds down to the final choice of “default or devalue.” While it may sound like the title of a popular TV game show, the choices facing Congress and the Administration are not going to be that popular, regardless of what they do. Massive but necessary cuts in the budget will only engender controversy and anger, while “default or devalue” necessitates higher interest rates and higher inflation. So while the U.S. government has some options, none of them are necessarily good. Like bonds, the U.S. dollar reflects that it too is quickly digesting this reality as it made a move for lower lows today, as we see in the daily chart of its proxy, the PowerShares US Dollar Index ETF (UUP). I see today’s action in both the TLT and the UUP as indicative of new lows coming for the bonds and the dollar, hence I believe the inverse ETFs for each, the TBT for bonds and the UDN for the dollar, are buyable here.

PowerShares US Dollar Index ETF (UUP) Gilmo Report Chart

Below are daily charts of each of these inverse ETFS, the TBT and UDN. Note that the TBT today flashed a pocket pivot type of move as it came back up through its 65-day exponential moving average.

Meanwhile, the bearish inverse dollar ETF, the UDN, flashed a pocket pivot type move back above its 20-day moving average four days ago, and appears headed for new highs, corresponding to new lows in the dollar.

UDN Gilmo Report Chart

And as bonds and the dollar continue to fall, my best-performing position remains silver, which moved to another all-time high today as it gets ever closer to the $40 mark, as we see in the daily chart of the nearest silver futures contract, below. There’s not too much to say here except that the trend remains our friend when it comes to silver, and as I stated on Fox Business News last Friday my upside target remains $50.50 until concrete evidence proves otherwise. I never like to get stuck with having to operate on the basis of a rigid upside price target, as it is more my “thing” to a) identify a trend, whether up or down, and b) go with that trend until it bends and ends. For now, silver’s trend is up, but I certainly would not be surprised to see the metal consolidate somewhere in the 40-50 price range on the way up. Nothing goes up in a straight line, but silver is certainly doing its best to look that way. In the near-term we can see that silver and SLV are trending along their 10-day moving averages, the faint magenta line in the chart below, which I consider to be a measure of the white metal’s “velocity” to the upside, so as long as it holds this near-term moving average it is still in “high-velocity” mode, while I ultimately rely on a violation of the 20-day moving average as my downside selling guide.

SLV Gilmo Report Chart

In my report of February 17th, when silver was still consolidating under $30 on the SLV, I was able to sniff out an impending breakout in the white metal. As well, in my report of this past weekend I sniffed out an impending breakout in gold, and this week we have seen gold move to all-time highs in the $1,460-an-ounce price range. As we see in the daily chart of the SPDR Gold Shares ETF (GLD), this is a clean, buyable breakout with a ready reference for a downside selling guide in the 140 price level, which is roughly the breakout point. The GLD has had decent upside runs when it has staged a clean breakout from a reasonable consolidation, and this looks like another one to me. As I wrote over the weekend, “…gold is on the verge of moving to a new high, which is why I also like the GLD or the 2-times leveraged gold ETF, the DGP, here as well.” With these breakouts in the gold ETFs confirming my view, I like them even more here.

SPDR Gold Shares ETF (GLD) Gilmo Report Chart

I like the combination of being short the dollar and/or bonds, and long silver and/or gold here as a hedge against what I see as unavoidable macro-trends in the dollar, bonds, interest rates, and inflation. If you are long leading stocks here, then you want to see how they act as they either test a key moving average, such as the 10-day or 50-day simple moving averages, or pull back to a prior breakout point. In most cases, however, such as with stocks like NFLX, BIDU, or LULU, for example, prior breakout levels are some distance away from current price levels, hence I would try to maintain some profit cushion in your positions without letting yourself get too far below your average cost on any pullbacks. A falling dollar and declining bond market could always send money into stocks as well, but it may be cleaner to play the trends in silver or gold as these will likely move higher in the event of a budget crisis that forces the issue of “default or devalue,” which is where I believe we are headed, one way or another. As well, long-term I believe the TBT and UDN may also be constructive vehicles to play a downside breakout in the dollar and/or bonds, both of which appear imminent. These are strange times, and they seem to get stranger every day, so stay tuned.

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, NFLX, TBT, and UDN though positions are subject to change at any time and without notice. Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2011 Gil Morales & Company, LLC. All rights reserved.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.