The Gilmo Report

August 10, 2011

August 10, 2011

Monday morning we got to see the market’s reaction to the S&P downgrade of the U.S. credit rating from AAA to AA+. I have to admit I found the extent of the sell-off to be somewhat surprising in that S&P had been telegraphing quite clearly that they would downgrade the U.S. if at least $4 trillion in cuts were not forthcoming in any debt ceiling agreement reached a week ago, so it was not as if we couldn’t see it coming. Thus I tend to think that the market’s action so far this week is less a symptom of present news. It may be that the S&P downgrade merely provides a ready alibi for the sell-off which is likely occurring as a result of the market beginning to discount something much worse down the pike. While I can understand the fear bid coming into gold and the Swiss Franc, it is interesting to note that money also piled into long-maturity Treasurys, as we see in the Barclay’s 20-year+ Treasury ETF (TLT), shown below on a daily chart. It’s very hard for me to imagine that money is being scared out of stocks and into Treasurys when it is those same Treasurys that have been downgraded to AA+ unless something else is amiss. Therefore I believe the market has worse problems ahead of it than what occurred over the weekend. Clearly, money flows are showing a movement into what is perceived as a “safe-haven,” and ironically Treasurys are one of them. Last week they were buying AAA-rated Treasurys, and this week they are buying AA+ rated paper at higher prices!

Barclay's 20-year+ Treasury ETF (TLT), Gilmo Report Chart

In over 20 years of trading as a professional, I do not recall seeing a sell-off right off the peak as persistent and brutal as this one. Usually, if they are this brutal they are much faster and have a sharp snap-back rally, but so far all this market can do is muster up one-day wonder rallies as we saw six trading days ago and yesterday. And meanwhile all I hear are commentators calling this a major “generational buying opportunity,” a concept I find quite ridiculous. March 2009, when stocks like Riverbed Technologies (RVBD) were selling for $3.55, and (AMZN) at 34.68 was more like what you would call a “generational buying opportunity.” Right now what we have on our hands is the first leg down of what may turn out to be a very bad bear market. Technically, we might still consider the market to be in the second day of a rally attempt, as we see in the NASDAQ Composite Index daily chart, below, and today’s sell-off did occur on lighter volume. The flip side of this is that the market is simply consolidating its recent downside move and is preparing to move lower. For now we simply sit back and watch.

NASDAQ Composite Index Gilmo Report Chart

In my report of this past weekend I showed a chart of the NASDAQ’s sell-off in late spring through summer of 2010, and how that initial, steep break off last year’s peak panned out. In 2010, however, it took three waves of selling to lower lows to take the NASDAQ 2000 Composite Index down 18.7% from peak to trough by the end of June, but here we’ve seen the NASDAQ down 21% in a little over two weeks. While I hear many commentators make comparisons to 1998 and 2008, this sell-off, given its amazingly steep descent, reminds me of March/April 2000, which I show via a daily chart of the NASDAQ Composite Index from 2000, below. The first big break off the peak took the market down just about 29% on an intra-day basis, and all the major market strategists were calling it a “v-bottom.” Three days later the market plummeted to 37% off the peak on the way to a final, complete breakdown of 41%. Notice how the sell-off had three waves selling off to new lows each time before the initial leg down in the 2000-2002 bear market was over with. Last summer of 2010 also had three waves of selling before the market bottomed in July, so my guess is we are looking at a sell-off that will turn out to be somewhere in between what last summer turned out to be and what the first leg down of 2000 turned out to be.

NASDAQ 2000 Composite Index Gilmo Report Chart

I felt pretty smart unloading my iShares Silver Trust (SLV) last week before it broke down over 10% from the peak, but unloading the SPDR Gold Trust (GLD) at the same time turned out to be a mistake. Given the profits made on the SLV position, and the fact that I am still sitting on a pile of physical gold, not ETFs, means I still have plenty of skin in the game. However, if you were using the 10-day moving average as a selling guide for the GLD, and the 50-day moving average as a selling guide for the SLV, you are still in both of them, and the SLV, which I don’t show here on a chart is trying to move up off its 50-day moving average but is still trapped in this current range below the $36 and $40, roughly. It is clear to me that silver is getting hit on the basis of its status as a major industrial metal, similar to the way copper, and oil for that matter, have been getting hit. Gold, however, relative to silver, retains its perception as “money” and as a store of wealth in its other primary use, jewelry. Currently, my Point & Figure charts are spitting out a $2090 upside price target for gold, and I definitely think this is attainable over the next year, maybe sooner.

SPDR Gold Trust (GLD Gilmo Report Chart

When I look at the action of gold and silver during stock market sell-offs, recent historical precedent argues for the fact that they eventually get dragged down with stocks, as they did in late 2008, but then bottom before the market. Even last year, as the SPDR Gold Trust 2010 (GLD) was breaking out to new highs in early May 2010 as the “Flash Crash” was occurring in stocks, it eventually got caught in all the stock market selling and came off about 8.5% off the peak. Today that would be around $150-an-ounce, so I would tend to see any pullback from here in gold as being confined to the $1600 level at worst. Long-term, however, I believe gold is a hold, particularly if one holds physical gold bought at lower prices. In the meantime, gold is well extended as money comes running into it and drives it towards the $1800 price level, well beyond my initial price target of $1700 from as recently as two weeks ago. But with gold refusing to go the way of stocks, we may be in a different situation. As one wise man said to me the other day, there comes a time when perception meets reality, and this just might be one of them!

SPDR Gold Trust 2010 (GLD Gilmo Report Chart

When the market splits wide open as it has over the past 2½ weeks, aggressive investors are always chomping at the bit to short everything in sight. As the market comes down now, some 17% straight down off the peak on the NASDAQ, that proposition becomes more risky. Indeed, as was written in “How to Make Money Selling Stocks Short,” the book I co-authored with Bill O’Neil, one looks to short into the first rally following the first major price break off the peak in the general market. So far we haven’t had any such rally as the market has dived lower in what has pretty much been a straight line. Over the weekend I discussed some “big stock” short-sale targets that might be developing into possible late-stage failed-base set-ups. But the only ones that are weak enough, (PCLN) and (AMZN), look similar to Baidu, Inc. (BIDU), below, in that they are all flirting with their 50-day moving averages, as we can see on BIDU’s daily chart, below. BIDU finds resistance at its previous trendline breakout, but it is not likely to break down toward its 200-day moving average unless the general market continues lower from here. I believe that while it is tempting to start shorting stocks that are in a position like BIDU is in here, it may be premature.

Baidu, Inc. (BIDU), Gilmo Report Chart


The bottom line with the short side is that I would much prefer to see what kind of rally the market can muster up here, as most stocks appear exhausted to the downside. Three down days within the past week where the general market averages have been off over 4% and headline moves of more than 500 points on the Dow might appear to be stretching the rubber band a bit too thin. Thus while it could snap, it can also snap back. Risk on the short side, as we saw by yesterday’s big turnaround rally, is higher here than it would be following a failed market bounce and rally. So it is therefore much more prudent, on a risk/reward basis, to be patient and wait for the right pitch to come down the middle of the plate. Otherwise, unless you own gold in some form or another, cash is king for now.

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 no positions, 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, 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. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.