The Gilmo Report

August 28, 2011

August 28, 2011

With the market so far “down and dirty” from its July highs, most stocks are “sold out” in the short-term, and in this position what isn’t able to kill the market may only tend to make it stronger. From my perspective, the action here is quite normal following a sharp sell-off, and the choppy and difficult action is illustrated quite well by the daily candlestick chart of the NASDAQ Composite Index, below. After the “Wyckoffian Retest” of early this week and Tuesday’s follow-through day, the final two days of the week saw a bearish outside reversal to the downside on Thursday followed by a bullish outside reversal to the upside on heavier volume. Going into Friday, the consensus was that the market would sell off if Fed Chairman Ben Bernanke did not allude to a nascent round of QE3 coming down the pike during his keynote speech at Jackson Hole, Wyoming on Friday morning. As it turned out, he didn’t, and the markets immediately began to sell off within a half-hour of the open. The crowd was set up to be fooled, however, as the market quickly found its feet and began rallying to the upside and staying there by the close, keeping the market’s rally, which appeared to be at risk on Thursday, alive. Meanwhile, leadership is scant to non-existent, keeping us mostly on the sidelines for now.

NASDAQ Composite Index Gilmo Report Chart

While the Fed Chairman did not explicitly announce any specific QE3 activities, he did allude to the broad range of “tools” available to the Fed in its quest to kick the can further down the road and keep the patient on its life support system. My guess is that when QE of all forms and via the use of all “tools” available to the Fed finally ends you will see a sharp rally in the dollar. The story of ever higher deficits, burgeoning national debt, and extreme fiat money-printing is seen in the 10-year daily chart of the U.S. Dollar Index, shown below. With the dollar down over 38% from its 2002 highs the stock market, in real terms, has made net negative progress when priced in U.S. dollars over the past decade. And so far it is showing no signs of rallying as it flirts with its early 2008 lows. Thus, until we see the dollar rally in earnest we can assume that QE, in some form or another and whether or not it is explicity referred to as “QE,” is still in force. And this likely means higher commodity and precious metals prices.

U.S. Dollar Index Gilmo Report Chart

The action of gold also argues for a continuation of QE as it consolidates recent gains and the sharp pullback that occurred this week as the Chicago Mercantile Exchange raised margin requirements 28%, effective Thursday. Obviously, this was leaked out as gold sold off hard on heavy volume prior to the announcement. As I wrote on Wednesday, I expected the precious metals to bounce back from the sell-off, which they did as we see on the daily candlestick chart of the SPDR Gold Trust (GLD), shown below. The GLD undercut its mid-August low at around 167.50 and quickly rallied back up above its 20-day moving average. The metal might need a little more time to consolidate here as it settles down, but I tend to view the sharp break off the peak as a) necessary given the steep run-up in gold since breaking out through the $1,559-an-ounce price level and b) “hot money” quickly adjusted to increased margin requirements by cutting positions. Many were talking about a steep, straight-down “bubble-bursting” in gold similar to what was seen in silver during May, but so far this is not panning out according to those who want to wish that the move in gold is somehow due to a “bubble.” Let’s make this perfectly clear, the move in gold is entirely due to the perception, rightfully so in my view, that paper, fiat currencies, over the long-term tend towards their intrinsic value, which is essentially the paper they are printed on, and that isn’t much.

SPDR Gold Trust (GLD) Gilmo Report Chart

Meanwhile, silver also got clocked in sympathy to gold as it tried to break out through the 41 price level on Monday, as we see in the daily candlestick chart of the iShares Silver Trust (SLV), shown below. The SLV found solid support at the 38 price level, and as I see it this pullback may have been necessary to “correct” the wedging action we see in the SLV prior to the breakout last Friday. Silver had been edging higher up towards the 40 price level on light volume, essentially wedging action leading up to the breakout, and this may have been the fatal flaw that made the breakout failure prone. With this sharp pullback holding at the 38 price level and the 20-day moving average, which the SLV did not at any time technically violate, the wedge may have been corrected enough to allow the SLV to consolidate and set up again for another attempt at higher-highs. Since its gap-up pocketpivot back in mid-July that took it back above its 50-day moving average the SLV has been hit twice with selling volume, and this most recent bout of selling occurred on less downside volume than the big hit the SLV took in the early part of August. This may be constructive as the SLV may be going through the process of shaking out weaker hands as it works its way up the right side of its chart pattern and towards the $50 high. My view is that silver will continue to work its way higher.

iShares Silver Trust (SLV) Gilmo Report Chart

It is important to understand that sometimes, even after the general market has made a significant, longer-term top, subsequent “bear market rallies” can create short-term environments where some leading stocks that did not break down with the general market top will continue to new highs. For example, look at a weekly comparison chart of the NASDAQ Composite Index going all the way back to mid-2000’s and focus your attention on the action following the general market top in October 2007. During that prior bull market phase leading up to October 2007, fertilizer and solar stocks were two of the hottest of the hot leading groups at that time. And among these were “big stock” fertilizer Potash, Inc. (POT) and First Solar, Inc. (FSLR). Notice that after the NASDAQ topped in October 2007 POT and FSLR both had pullbacks in synchrony with the market off the peak. Going into early March of 2008 the market made a short-term bottom and began a short bear market rally during which both POT and FSLR streaked to new highs, and investors who were onto those early found profitable short-term trading opportunities in these stocks as they streaked very rapidly into new high price ground. While it may be too early for a “real” bear market rally to take hold currently, it is something to be aware of, so that those leaders still holding up should be watched throughout any bear market.

NASDAQ Composite Index Gilmo Report Chart

The problem right now is that there aren’t aren’t many constructive-looking leaders, but one does stand out currently. When I wrote about Apple, Inc. (AAPL) in my report of this past Wednesday I did not know at the time that the company would be announcing Steve Jobs’ resignation as Chief Executive Officer of the consumer technology juggernaut. At that time, I noted the cautionary action in the stock, and it appears that perhaps the stock did know something as the news of Jobs’ departure from the CEO position hit the wires later Wednesday afternoon, sending the stock plummeting down into the 355 price area in after-hours trading. By Thursday, however, the shakeout was on as the stock opened above its 50-day moving average, as we see in the daily candlestick chart below, and closed above the 10-day moving average and near the peak of the daily trading range, resulting in a white candle body despite being down for the day only 2.54 points or -0.65%. What is interesting here is that volume on Thursday was higher than any volume over the prior 10 trading days, which qualifies as a pocket pivot volume signature. Technically, because the stock did not close up on the day this is not an exact pocket pivot buy point. However, it did close above its 10-day moving average and found very strong volume support at the 50-day moving average, thus the action is still highly constructive.

Apple, Inc. (AAPL) Gilmo Report Chart

On Wednesday I surmised that another break of the 50-day moving average for Apple, Inc. (AAPL) could be trouble, but instead the stock held above the 50-day moving average on “bad” news. But as the situation with Steve Jobs resolves over time this may actually serve to remove some of the uncertainty hanging over the stock. The stock sells at 14 times estimates, a curious valuation for what I like to call the consumer technology growth juggernaut of the New Millenium given its 122% accelerating earnings growth in the most recent quarter, and I have often wondered if this is the “Steve Jobs Discount” when it comes to how the market values the company’s future earnings stream. If the resolution to a worst-case outcome for Jobs’ illness continues to gain clarity, this could lift the uncertainty that weighs on the stock. On the weekly chart, below, support along the 10-week (50-day) moving average is obvious as the stock builds what is so far a five-week base. Meanwhile, AAPL’s Relative Strength is a very strong 95 according to Investor’s Business Daily and 92 according to HGS Investor. In both cases the relative strength line is making a new high ahead of the stock price. Feel like taking a shot? If so, then the 10-week/50-day moving average at 368 becomes your selling guide.

Apple, Inc. (AAPL) Gilmo Report Chart

Running through my screens this weekend, I only found three stocks that look even remotely buyable in the face of this past Tuesday’s market follow-through day, AAPL being one of them. After that, one has to look hard for anything acting reasonably constructive, much less a leader that isn’t simply staging a reflex bounce after getting decimated throughout most of August. One big leader that has been able to hold its 10-week/50-day moving average throughout the market break in August has been MasterCard, Inc. (MA), shown below on a weekly chart. MA tried to break out of a three-week flag formation in early August but the market’s correction and break off the peak got in the way of that breakout attempt as the stock moved below the 10-week line the next week but by the weekly close was able to rally back up to the prior week’s highs. Thus we get two big-volume supporting weeks off the 10-week line, and while some may think they look like “railroad tracks” I don’t find that conclusive at all. What is conclusive is that the market is correcting hard and MA doesn’t want to budge – that is constructive action to take note of.

MasterCard, Inc. (MA) Gilmo Report Chart

The third stock is Hansen’s Natural Corporation (HANS), which is only too obvious since it is the only clean breakout to occur in the midst of the market’s sharp August correction. HANS’ latest hot product is the “Monster” energy drink, which my younger brother tells me is very popular in the hospital emergency room where he works. Meanwhile the “M” logo they use for the drink looks like something straight out of the “Addam’s Family,” but teenagers seem to think it looks “cool” emblazoned on a t-shirt, preferably a black t-shirt. HANS has broken out of a seven-week base with a couple of nice-looking support weeks at the lows of the base where the stock closed in the upper part of the weekly range on huge volume after pulling back intra-week in both cases. HANS closed at 84.63 on Friday, just two points, roughly, above what I see as an 82.33 buy point so it remains well within buying range. One could theoretically buy this using the standard 7% downside stop that we use on all base breakout buys.

Hansen's Natural Corporation (HANS) Gilmo Report Chart

Certainly, if one wants to play this most recent follow-through day, you have three choices right now, as I see it, in AAPL, MA, and HANS, which isn’t much. Meanwhile, I tend to think the market wants to rally further here, perhaps taking the NASDAQ Composite Index into the 2600 price level where potential, significant resistance lies. If that happens I could see AAPL getting back up through the $400 price level, and in fact it remains one of the most interesting stocks in the market from my perspective given all the twists and turns in its chart pattern and company news flow recently, in addition to its status as the “Consumer Technology Juggernaut of the New Millenium.” With the AAPL story remaining so compelling, and the stock not blowing to pieces as the Steve Jobs story continues to clarify, perhaps AAPL will only finally top as most of the biggest of the big leaders tend to: with a climax top.

Meanwhile, with the market showing little inclination to roll over here, the short side of the market is put on hold as we let the market do its thing. As I have discussed in previous reports, we must understand where we are in the current “big picture” as the market has come down very hard in August and the need to sell becomes just too obvious in the short term. I think it will take a couple of more weeks before we might see another sharp break to new lows, if that does in fact occur. Gilmo members can view my month-end video presentation for more details at:

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 AAPL, AGQ, and DGP, though positions are subject to change at any time and without notice.

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