The Gilmo Report

March 16, 2014

March 15, 2014

In my mid-week report of this past Wednesday I set forth my “alibi” theory for more market downside, and so far the market action is doing its best to prove that theory correct. The daily chart of the NASDAQ Composite Index, below, shows a big, ugly outside reversal on huge selling volume Thursday, making for two big-volume down days on the index out of the last four and the third one since the big-volume churning day of three Fridays ago. The index attempted to rally on Friday, essentially “pole dancing” around the unchanged level before finally reconciling itself to a lower close on lower volume compared to Thursday, but still above average. It looks to me as if the NASDAQ is trying to hold support at the prior recent lows in the pattern, as I’ve highlighted on the chart. It didn’t have enough thrust behind it on Friday to sustain what was actually an intraday upside reversal before it gave up the ghost and closed lower. Right now the index appears ready to test its 50-day moving average at 4203.55, which would also undercut the low of two Mondays ago.




The S&P 500 Index, shown below on a daily chart, is in a similar position as it approaches its own 50-day moving average and the prior lows of late February and early March. The situation in the Ukraine continues to give the market jitters, and with Russia having, for all practical purposes, annexed the Crimean peninsula, fears of Russian troops invading the rest of the Ukraine remain high. The U.S., the Europeans, and their allies all threaten economic and political sanctions, but a military response does not appear to be in the cards. Thus I tend to think the road is open for the Russians to enter the Ukraine and do as they please as the Russians counter the west’s threats of sanctions with their own threats of dumping U.S. Treasuries. Because the situation is fraught with uncertainty, the market naturally does not like it, and my guess is that a certain sort of softness will accompany the market’s action as long as the uncertainty persists. If the situation deteriorates, the market may sell off harder and further, but if a resolution is found we could see a big snap-back rally as we did two Tuesdays ago.




Gold continues to move higher in the face of a number of factors, including the Ukrainian crisis and a continued drop in the U.S. dollar, as the daily chart of the Gold Index shows below. For now the uptrend remains intact as gold appears ready to test resistance near the $1425-an-ounce price level. Curiously, silver, not shown here on a chart, has been drifting downward after an initial upside pop in February. One must remember that silver is also an industrial metal, and fears of a global economic slowdown can certainly mute any upside in the white metal.




But as the price of gold goes up another key metal, copper, has experienced a sharp and sudden breakdown over the past week, as we can see in the daily chart of the iPath Dow Jones UBS Copper (JJC) ETF, below. Given copper’s status as a primary industrial metal used in everything from electronics to housing, its price is seen as an economic indicator of sorts, and we have to wonder what copper is telling us as the bottom drops out and it moves to its lowest levels since June of 2010. China makes up about 42% of world copper demand, and fears of a Chinese economic slowdown and accompanying “shadow” banking crisis have added to the uncertainty already being provided by the Ukrainian “festivities.”

While I tend to look at the situation in the Ukraine as something that will pass, one way or another, I am more concerned with what this chart may be telling us. Copper has been in a steady downtrend since 2011, and is now breaking down through the neckline of a big head and shoulders formation. If we consider that leading stocks started to tell us that the market was heading for a little trouble over a week ago, we can also see that copper was giving a similar message at about the same time. All of this adds up to one conclusion, which is that investors should exercise extreme caution, taking profits where they have them and looking to raise cash.




With the market continuing to pull back, most leading stocks are doing the same, and the deeper the market corrects the further leading stocks pull down into their patterns. With names like Facebook (FB) and Netflix (NFLX), both not shown, you are seeing pullbacks that have failed to hold the 20-day moving average. This of course brings the 50-day moving average into play as a potential area of support if and as the stocks continue to pull back. In a situation like Tesla Motors (TSLA) where the stock is pulling into the 20-day exponential moving average you are for the most part approaching the point of no return. TSLA is also testing the intraday low of the early February buyable gap-up move, and if the general market continues to weaken I would be looking for the stock to potentially fill that gap down underneath the 220 price level.

Another way to look at this is to note that since the early January bottom-fishing pocket pivot TSLA had not violated the 10-day moving average for more than seven weeks. Using the Seven Week Rule one could view a violation of the 10-day moving average as a sell signal. TSLA has violated its 10-day line over the past few days, so in my view it could be sold on this basis. I tend to think that TSLA needs more time to at least work on a new base, and this could include a nice shakeout through the 20-day line and the BGU intraday low at 228.45. Keep in mind that as of the end of February, TSLA still has over 31 million shares sold short, indicating that short-sellers were not persuaded to cover on the late February BGU (buyable gap up).




What you would like to see TSLA do is something similar to what Keurig Green Mountain (GMCR) did on Friday after the company announced a deal with Peet’s Coffee & Tea on Friday, helping the stock to come back from its post-BGU decline, as we can see on the daily chart below. Friday’s action constituted a pocket pivot buy point, but I would not act on it first thing Monday morning unless we see some sort of recovery in the market. Alexion Pharmaceuticals (ALXN), not shown here on a chart, had a similar pocket pivot earlier this past week, but all it has done since then is drift back into its 10-day moving average in consolidating fashion. GMCR might do the same, so I would keep it on my buy watch list in the event that the general market is able to find its feet soon. In fact, investors should keep an eye on all leading stocks that show buoyant tendencies as they hold up relatively better than the general market during a correction, regardless of its duration.




Intrexon Pharmaceuticals (XON) is another one to keep on your watch lists as it flashes three pocket pivots along the lows of a potential new base. I first discussed XON in my report of January 12th as it was in the midst of its big upside romp in January. Following an IPO lock-up expiration on February 4th, the stock has trended steadily lower but finally found a bottom about three weeks ago when it had a huge-volume bottom-fishing pocket pivot right off the lows, as we can see in the daily chart, below. XON is a unique bio-tech company that purports to be creating “A Better World through Better DNA” by providing “comprehensive synthetic biology solutions while other companies simply build DNA parts.” Even better, insiders appear to be putting their money where their mouths are as one director took advantage of the stock’s post IPO lock-up expiration decline and purchased over 100,000 shares between February 28th and March 4th.

The three big volume spikes in the pattern off the lows of about three weeks ago also indicate that he isn’t the only person or entity snapping up shares off the lows. You might also notice on the daily HGS Investor chart, below, that the stock is going “code blue” as all the indicators flash blue, and Wednesdays pocket pivot also flashed a dark blue “Kahuna,” which is generally a strong buy signal. This is one to keep an eye on as XON seems to be ignoring the general market malaise over the past week or so as it was able to power above its 50-day moving average in a very strong-volume pocket pivot this past Wednesday. It might even be buyable right here in the face of a weak general market with the idea that it will continue to hold above the 50-day moving average as it has done over the past two days since the Wednesday pocket pivot.




Believe it or not, I have made small profits shorting Finisar Corp. (FNSR) over the past two trading days, based on the general market weakness. I did discuss the stock last weekend after it flashed a stalling pocket pivot buy point (see March 9th report) on its daily chart, not shown. Despite making small profits shorting FNSR, one key bit of market feedback I’ve been able to glean from a visceral standpoint is that there appears to be a strong bid in the stock, and this underlying strength shows up on the weekly chart, below. The stock is essentially building a long “ladle-with-handle” type of formation with a nice shakeout in the ladle handle six weeks ago. The past two weeks have seen the stock pick up some big-volume support on dips below the 10-week line, closing above the line for two weeks in a row. This past week the stock closed at the top of the weekly range. While its cousin stocks like Ciena (CIEN) have floundered, FNSR is holding up just fine.




Michael Kors Holdings (KORS) is another one to keep an eye on as it moves tight sideways with four consecutive weeks of excruciatingly tight closes, as we can see on its weekly chart, below. In stark contrast to the market’s gyrations, KORS has been as steady as a rock over the past four weeks as it trades around in a very tight weekly range and closes tight week after week. One could watch for a pocket pivot to develop along the 10-day moving average as the stock holds up around the line. Currently KORS’ 20-day moving average is moving up to meet with the 10-day line, and the stock has been pulling back right into the 20-day line over the past few days on low volume. KORS should be on your buy watch list.




Global Eagle Entertainment (ENT) had a nice little spin-out on Thursday that led to a brief break below its 50-day moving average early on Friday before it was able to find support and close in the upper half of its weekly range, as we can see on the weekly chart below. While Gogo (GOGO) has fallen apart following its earnings announcement on Thursday before the open, ENT remains viable in the airline Wi-Fi service space. What I notice here on the weekly chart is that the stock is having the third pullback in what could be seen as a 13-week ascending base. Watch for a possible pocket pivot coming back up through the 10-day moving average as a signal to come back into the stock on a possible ascending base breakout.




After a big buyable gap-up move that I discussed in my February 26th report, Zulily (ZU) peaked out a day later and since then has been trying to settle down, as we can see on its daily chart, below. There are a number of conflicting numbers out there with respect to the stock’s current float. O’Neil shows a float of 3 million shares, while other sources show a float of 123 million shares. Logic, however, would tell us that simply checking the number of shares that were issued at the time of the stock’s IPO in November of last year, 11.5 million shares, would give us the stock’s current number of shares circulating out there in the market place.

Getting the float correct is critical in trying to understand what kind of a short squeeze ZU had when it began to gap up towards the end of February. As of February 14th, prior to the big buyable gap-up, ZU had 2,482,785 shares sold short against a float of 11.5 million shares. As of February 28th, after the buyable gap-up, ZU now shows a peak of 3,157,310 shares sold short. This means that on balance short-sellers increased their short positions into the buyable gap-up. Meanwhile, ZU is trying to tighten up as it oscillates following the late February peak, and what catches my eye here is the extreme volume dry-up on Friday as the stock settles around its 10-day moving average. If the general market doesn’t break down next week, there is a decent chance that ZU could have a tradable rally back up towards its recent highs, and some of this could be generated by short-covering. I would watch for the stock to continue to tighten up here along the 10-day line since the weekly chart, not shown, merely indicates that the stock is trying to form a high, tight flag formation.




Among my short-sale ideas, I’m still looking at LinkedIn (LNKD), not shown, as being shortable into rallies up towards the 50-day moving average. LNKD had a quick head fake to the upside on Thursday morning before rolling over and dropping below the $200 price level. At a close of $196.78 on Friday, the stock is in “no-man’s land” and is not in a shortable position. It would need to rally back up towards the 20-day line at 203-204 before I would consider shorting the stock again. Meanwhile Cree (CREE) is resisting further downside as some decent buying interest came into the stock on Thursday, as we can see on the daily chart, below. As can be seen on the chart, CREE was definitely going “code red” until it had a strong-volume upside move on no news that I could find. Now we see my indicator bars at the top of the chart turning blue with a small “Kahuna” showing up on Thursday. One could have made a few dimes shorting the stock right at the 50-day moving average on Thursday and Friday, given that the stock stalled out on Thursday and then closed near the lows of its price range on Friday.

However, the situation with CREE remains muddled as far as I’m concerned. It may be that buyout rumors are circulating somewhere out there, giving the stock its upside impetus on both Thursday and Friday, but the fact that the stock has stalled out at its 50-day and 200-day moving averages still makes it look shortable at that point. If one is short CREE here on the basis of the failed rallies into the 50-day line, then I think a quick upside stop at Thursday’s 62 intraday high would be prudent. As I watch the stock trade every day, I have to admit that I’m also open to going long the stock under the right conditions since for all we know it is still working on the lows of a potential new base. Thus I think acting on the basis of the current price/volume action and letting that guide you rather than getting locked into a bearish frame of mind on the stock is the best way to handle this for now.




Despite the market turmoil over the past week or so, I am seeing constructive action in some stocks, which qualifies them for inclusion on my current buy watch list. On balance, however, the action of leading stocks remains weak, and the index action on Thursday and Friday remains bearish, at best. With a potentially deepening crisis in the Ukraine this coming week and continued fears of a China slowdown/banking crisis, the news flow remains decidedly negative.

Thus I remain on the sidelines as I allow the market to sort itself out. Short-selling for now remains primarily a short-term “hit and run” tactical affair, and I have been able to make some small progress on the short side in stocks like LNKD and a couple of other stocks that had short-term breakdowns this past week. In the meantime, I have my handful of stocks to watch as potential buys should the market find its feet, although I tend to think that we are going to see further downside before this current correction is over, assuming it doesn’t develop into something worse. Stay nimble and look to play a strong defense as the correction runs its course.


Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and Principal, 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 no positions, though positions are subject to change at any time and without notice.

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