The Gilmo Report

August 24, 2011

August 24, 2011

The support around the 2310 level on the NASDAQ Composite, shown on a daily chart below, held on Monday as the indexes all staged a classic “Wyckoffian Retest,” as I call it in reference to Richard D. Wyckoff, who originated this idea of a low followed by a lighter-volume pullback and retest which was discussed in the book, “Charting the Stock Market: The Wyckoff Method,” by Jack K. Hutson. I should also note that my Gilmo Report colleague Kevin Marder discussed this sort of retest and short-term bottom on Monday in his MarketWatch.com column that afternoon, so he also saw it coming. Thus Tuesday’s massive bounce, was not all that surprising to see coming up off of the support levels I discussed over the weekend that stocks are roughly defined by the top of the market’s range during the correction of summer 2010. As well, scores of leading stocks that had been decimated were in “deep down” positions from whence to stage natural reflex bounces. If anything, Tuesday’s bounce and rally shows how bear markets can have sharp, upside rallies. How far this rally carries is as yet uncertain, although yesterday’s action did count as a technical follow-through day. The fact that there is no leadership set up in proper buy positions, e.g., breaking out of proper bases, places the follow-through in question, and so I would expect that at some point we will see a rally failure. But for now you’ve got a rally on weakening volume as the index heads for the top of last week’s gap-down.

NASDAQ Composite Gilmo Report Chart

The key here, as I wrote over the weekend, is understanding where we might be in the market’s downdraft. I don’t believe yesterday’s follow-through will turn out to be the start of a new bull phase unless Fed Chief Ben Bernanke explicity alludes to another round of QE. While QE3 or QE 2.1, whatever you want to call it, might spawn a rally in stocks and commodities, it is not clear to me whether it will have any effect on the economy given the track record of QEs 1 and 2 in this regard. Nevertheless, the rally could bounce around in a “chop zone” as seen on the NASDAQ Composite, similar to what it did last summer during the infamous “Flash Crash” correction. After one sharp break off the peak, one rally, and then a break below those initial lows that led to an “undercut & rally” situation, the market then slopped around for about a month before breaking down sharply into the end of June, as we see in the below chart. Thus we could be looking at a similar period like that, or at least until September rolls around and “participants” allegedly return from summer vacation.

NASDAQ Composite Gilmo Report Chart

The breakout we saw last week in silver flat out failed today as we see in the daily chart of the iShares Silver Trust (SLV), below. Whether the metal tries to break out again remains to be seen, but it has roughly retraced back down 50% from the original rally point down at the 50-day moving average. Today’s close below the 20-day moving average brings into play a potential violation of the 20-day line if the SLV moves below today’s intra-day low at 38.05. My view is that if it cannot hold the trendline breakout as I’ve outlined on the chart then it is best to back away and let the SLV reset. Thus, I’m out of my silver holdings for the most part. At the very least I would expect silver to try and hold the 50-day moving average if this pullback continues. In fact, if you bought the original pocket pivot at around 37 in early July and have used the 50-day moving average as your selling guide, you were never stopped out, interestingly enough. However, the way the SLV has changed character means that it is quite likely that it needs more time to continue basing here before it becomes playable again.

iShares Silver Trust (SLV) Gilmo Report Chart

The SPDR Gold Shares (GLD) may be in a similar situation as it has finally succumbed to profit-taking after a short-term climactic move. The GLD is fully entitled to pull back and consolidate here given its rapid run-up since breaking out through 151.86. I indicated in previous reports that with the GLD in such an extended state one could use the 10-day moving average as a selling guide. Therefore, there would have been nothing wrong with selling the GLD today once the 10-day moving average was broken. Alternately, one could wait for a technical violation of the 10-day moving average first by allowing the GLD to move below today’s intra-day low, completing the technical violation, before closing out any GLD position. There is potential for it to bounce here as it approaches the 20-day line just below at 169.07, but for now I think the yellow metal needs some “digestion time.” Longer-term, however, I think the precious metals go higher, thus our alternate strategy of buying the metals when they are unloved and “quiet” comes into play as they pull back. Stay tuned.

SPDR Gold Shares (GLD) Gilmo Report Chart

Over the weekend I discussed the positions of former leading stocks that had broken down severely in the market’s sharp break off the peak. Given that most of these fallen leaders look like Amazon.com (AMZN), shown below on a daily chart, I don’t give yesterday’s follow-through a high probability of succeeding. Likewise, some of the action on this natural reflex rally is suspect. For example, we can see that AMZN came down hard last week and undercut its prior June low as it broke below the 200-day moving average, setting up a classic “undercut & rally” sitituation. Would-be short-sellers of AMZN might consider testing it on the short side here at the top of its prior gap-down “falling Window” move of last week. Note how volume is wedging slightly as it declined today, but was still above average as AMZN churned around on the day, closing roughly mid-range. If the market rally fails around current levels, AMZN is likely to turn lower as well. But if the market continues to edge higher, which it could, AMZN may simply push up towards the 50-day moving average.

Amazon.com (AMZN) Gilmo Report Chart

While one can take initial short positions into these rallies, if the stocks have come up into logical areas of resistance, remember that keeping tight stops of around 3%, 5% maximum, is advised since they could continue rallying. While my tendency is to view this current rally as likely to fail, there is always the possibliity that it can go on further than one thinks. And while situations like AMZN skirt past a key moving average and find resistance at a prior gap-down level, Potash Corp. (POT) illustrates another type of move into resistance right at the 50-day simple or 65-day exponential moving averages. As we see on POT’s daily chart, below, last week it found solid resistance at the 50-day simple moving average. Today the stock ran right into the 65-day exponential line on weak volume as it wedges up into moving average resistance. Thus it could be tested here on the short side using a 3-5% stop, or simply using the prior high at the 50-day moving average as your stop.

Potash Corp. (POT) Gilmo Report Chart

 

If we see how AMZN is moving up into potential resistance around its prior gap-down and “falling Window” from last week, and POT is running up into potential moving average resistance at the 65-day exponential line, we can also see a third example of resistance in the form of “overhead congestion” in Priceline.com (PCLN), shown below on a daily chart. Notice how PCLN, like AMZN, also undercut its prior June lows before staging a classic “undercut & rally” move back above its 200-day moving average. This move is now pushing up into a zone of potential resistance around the early August lows, as I’ve highlighted on the chart. PCLN could always continue to rally into the 50-day moving average around 506. But the first place to test shorts is here in this zone of “congestion” from earlier in the month when PCLN was bumping along just below its 50-day moving average before it gapped to the downside.

Priceline.com (PCLN) Gilmo Report Chart

Chinese internet company Sina Corp. (SINA), which I discussed over the weekend, is oscillating around its 200-day moving average as we see in its daily chart below. Unlike other beaten-down leaders, it has not been able to move much as the market has rallied sharply over the past two days. For now the stock remains below its 200-day moving average, and I would look at the top of this range over the past three days at around 96 as near-term resistance and an upside guide for a stop. Sohu.com (SOHU), which I don’t show here, found similar resistance in its pattern, but at the 50-day moving average instead of the 200-day moving average as SINA has. SOHU’s upside guide for a stop would be the 50-day line at 76.25. Meanwhile, BIDU, also not shown, holds above its 200-day moving average as it remains in a late-stage, failed-base type of set-up. But I consider SINA and SOHU to be the two weaker Chinese internets that are finding volume resistance at their respective 200-day and 50-day moving averages. Also, they have shown no tendency to rally with the market over the past two days, so those are my two main short-sale targets in this realm.

Sina Corp. (SINA) Gilmo Report Chart

Apple, Inc. (AAPL) remains the only big-stock NASDAQ leader holding above a recent new-high base breakout point, as we see on its daily chart below. Its action is interesting, in that the stock is finding trendline resistance that also coincides with the green 20-day moving average line. Often, stocks that fail on a breakout attempt and push below their 50-day moving averages will have one or two rallies back up into the 20-day moving average. While it can be argued that AAPL never broke down below its 50-day moving average it will be interesting to see how it continues to play out in this current market bounce and rally. Is this trendline and 20-day moving average resistance significant? If AAPL does pull back and head for the 50-day line again, will the Rule of Three mean that it will fool the crowd by busting decisively through the 50-day moving average? And finally, seeing what we see on the AAPL daily chart, are we brave enough to stick our necks out and short the stock here using today’s high as a quick stop? This is called pulling a short-sale idea out of your you-know-what, but who knows, it could work if the market rolls over soon!

Apple, Inc. (AAPL) Gilmo Report Chart

To sum up, we are in a market bounce and rally that resulted from a classic “Wyckoffian Retest” as the market successfully tested its prior lows this past Monday. This is logical given the extent of the market’s prior decline, and we now have a market rallying on the basis of yesterday’s technical follow-through. The lack of leadership participation with respect to stocks setting up in proper bases is stark, however, and puts the market in the position of having to prove itself here. In the meantime, we see certain short-sale target stocks rallying up into logical resistance, and it is thus possible to test short positions into these rallies where resistance may come into play. However, success in selling short these rallies will depend on how far this market rally goes on the heels of yesterday’s follow-through, leaving us in somewhat of a waiting game. If one does intend to put out short positions into rallies carrying up into areas of logical resistance, then it is advisable to use 3-5% stops as these stocks could continue to rally further than one expects. My strategy, therefore, is to wait and watch to see how this rally pans out, testing the short side judiciously while keeping such positions on a short leash. It may be that the time is not exactly right for getting aggressive on the short side, but my guess is it will eventually be again in the coming days or perhaps weeks, much as we saw from late May to late June of last year, as the market entered a one-month “chop zone.”

Stay tuned, and tune in tomorrow to Fox Business News where I will be appearing on the Stuart Varney & Company show at 6:45 a.m. Pacific, 9:45 a.m. Eastern Time.

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, and SINA, though positions are subject to change at any time and without notice.

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