The Gilmo Report

December 28, 2011

December 28, 2011

It looks like the crowd perhaps became a bit too complacent as the popular expectation that this week would be “calm with an upside bias” needs to be amended with “LOL.” The market provides us with a perfect illustration of why one should never assume anything at any time, and so today’s sell-off catches a complacent crowd off guard. Somewhere out there, Homer Simpson the Investor is heard to yell, “Doh!” The real story here, and what it means for the market, in my view, is the action in gold and what that may be telling us, a concept I’ve discussed in prevous reports recently. Gold’s move below the 200-day moving average, even as the Europeans are supposedly opening up their own QE-spigot, is the first since August of 2008, and it may be telling us that QE does not have the same traction right here and now, at least not when it comes in the form of Euro-QE. If the printing presses are rolling at full speed, why isn’t gold rallying sharply? As we see on the daily chart, the SPDR Gold Shares (GLD) printed new lows today as it “broke out” to the downside and continues to move away from the 200-day moving average. Something is not quite right with the QE equation, and gold’s action may be the clue.

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Meanwhile, the NASDAQ Composite yesterday staged its own “breakout” through the top of its own sideways triangle formation just like the S&P 500 did last Friday. But this only served to suck in the unwary as the index reversed today, essentially rolling “over and under” the 50-day moving average with volume picking up today. If the market has an upside bias going into year-end it was certainly not demonstrating that bias today, that much we know for sure. My concern here is that the action in gold will be similar to 2008 when it presaged a sharp downside break in stocks that occurred a little over a month after gold broke down below its 200-day moving average in August 2008, as I discussed in my report of December 18th. While volume picked up today, it is still well below average, and so the action over the next two days may get interesting. I can’t say for sure whether gold’s breakdown is a certain indication that stocks will soon follow to the downside, but I would say that if it is, the action over the next few days and going into January may not be so sanguine.

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Maybe a second downleg in a continuing bear market is in the offing here, and the action of gold is your first clue. The bear market of 2007-2009 started out with a first downleg in November of 2007, and the end of the year saw the usual Santa Claus Rally. But as we see in the daily chart from that period, below, the index ran out of gas three days before the end of the year. The NASDAQ finished the year with three days of selling off, and it then greeted the New Year with a brutal January sell-off that started things out with a bang. The bottom line for me is the action of gold and what that is telling us about the traction that QE is getting in this environment. If QE isn’t sufficient any more to rally stocks, then on what basis can stocks be the beneficiaries of money flows into equities? Could we see another January sell-off like that seen in January 2008? If so, then it would be a short-seller’s dream opportunity so stay alert here.

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Meanwhile, the market’s action here emboldens me to begin testing short-sale positions among my short-sale target stocks. As I wrote over the weekend, Apple, Inc. (AAPL) and Amazon.com (AMZN) don’t strike me as being in the most optimal of shortable positions within their chart patterns, but certainly if the market gets hit they will likely get hit as well. I’m looking at those short-sale targets that have rallied up into logical resistance and either are or may potentially begin to turn tail. Among these is Salesforce.com (CRM), which I show on a daily chart, below. The stock has rallied tepidly after a big exhaustion-type gap five days ago, and can’t seem to get past resistance in the 100-102 price area. It appears possible to test a short position here, using the 102 level as a quick stop. Given that this is about 2% away from today’s close, you could also elect to give it a bit more room, say 3-5%, as far up as the 105 level if you can handle the risk. The point here is that if the market does weaken into year-end as it did in late 2007, I tend to want to begin laying ’em out here on the short side.

Salesforce.com (CRM) Gilmo Report Chart

Another one at logical resistance is Baidu, Inc. (BIDU), which did hold up fine today but has been unable to move above this zone of resistance that I’ve highighted on the daily chart below. I’m using the 118-120 area here as a very tight stop for BIDU. Volume was up today and the stock got a little bit of a bid today on news that it was rated the #1 Open Internet Platform in China, a news-oriented bump that I viewed as potentially shortable. BIDU closed roughly flat today, but it remains below resistance and in this large head and shoulders formation that I discussed in detail in my report of December 14th. If the market continues to weaken here then I would expect BIDU to roll over along with CRM, keeping in mind that in a light-volume environment using quick stops is of paramount importance. I think in the case of both BIDU and CRM, their chart positions create potentially lower-risk entry points on the short side, and if the market does in fact move lower over the next two days, the chance of them following its lead increases following bounces off of their recent lows.

Baidu, Inc. (BIDU) Gilmo Report Chart

The weakest of my short-sale target stocks today was Fossil, Inc. (FOSL), which rallied right into the middle of the zone of resistance I first discussed in my report of December 21st. Over the weekend I advised easing up on the gas on the short side here as I preferred to let the market rally at the beginning of this week. Today we see things begin to weaken and FOSL led the way on the downside by reversing hard today on increasing volume. Volume was not above average, however, but today’s action sets up the potential for a downside “breakout” through support at the 80 level, which is what will have to happen before any major down leg in the stock occurs from present price levels. At this point I would look for resistance around 84 on any bounce that occurs from here, which is only a couple of percent on the upside from here. In the case of FOSL, however, one can get a sense of how we monitor these things as they rally into zones of potential resistance, waiting for the stock to show signs of weakness before coming after it again on the short side.

Fossil, Inc. (FOSL) Gilmo Report Chart

Over the past several months, whenever the market has started to look better on the upside, and even flashed a standard follow-through day here and there, it has not sustained any continued upside movement. Thus, peaks in the market’s chart pattern since late August have served as inflection points back to the downside. Yesterday’s trendline breakout turned into a fakeout, and those holding stocks on the long side are left hoping for a recovery over the next two days. While any pending movement in the market is still in its early stages, the clues are there to begin thinking about jumping in on any break to the downside. Otherwise, the long side offers little to sink one’s proverbial teeth into, but a resolution to this “triangulating” market may soon be at hand.

Gil Morales
CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, Virtue of Selfish Investing, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC held a positions in BIDU, CRM, and FOSL, though positions are subject to change at any time and without notice.

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