The Gilmo Report

November 6, 2011

November 6, 2011

The NASDAQ Composite Index remains the market’s leading index as it engages in a battle to take and hold its 200-day moving average. The daily chart below tells a story of sharp volatility over the past three weks as the index’s swings have widened each of the three times it has tested the top of its prior range, as I’ve highlighted on the chart. Much of this remains news-oriented as the news du jour out of Europe seems to send the indexes gapping up or down overnight in random fashion. Friday night, Greek Prime Minister Papandreou got his vote of confidence, setting the stage for additional aid from the rest of the European Monetary Union, also known as fiat money-printing. And while the Fed talks about starting to buy up mortgage-backed securities in another QE attempt to revive the economy, they haven’t actually gone through with it, perhaps because in the backs of their minds they know that QE1 and 2 did nothing to help the economy, and QE3, othewise known as “Operation Twist,” is likely having the same effect. Thus they may find that propping up markets simply by talking and cooing about a possible QE4 is more effective than actually proceeding with the act of another round of money-printing itself. In the meantime the market chops around here as it does its best to confuse investors.

NASDAQ Composite Index Gilmo Report Chart

The volatilty in the market over the past few weeks gains some clarity when we back away and distill things down to the view in a weekly chart as opposed to a daily chart, as I’ve done with the S&P 500 Index, shown below. Despite all the news-oriented volatility, the weekly chart of the S&P 500 seems to show a market that underneath it all is trying to move higher. Note that the four week move off the early October lows shows the index closing at the absolute peak of each weekly range on the way up. It was not until the S&P 500 ran into the 200-day moving average and an area of potential overhead congestion and resistance, as I’ve highlighted on the chart, that it finally backed down from its heady straight-up-from-the-bottom move in October. As well, if you look at a weekly chart of the NASDAQ, which I don’t show here, you will find that all five weekly price bars since the early October turnaround show the index closing at or very near to the peak of the weekly range, a sign that the NASDAQ is also trying to move higher. But the “Naz” also has some overhead resistance and congestion as well as its 200-day moving average to contend with here, and it is not clear what sort of catalyst is needed to push it beyond current levels of resistance, and so we remain in the “Land of No Fat Pitches.”

S&P 500 Index Gilmo Report Chart

Without any “fat pitches” coming down the middle of the plate when it comes to stocks, I might consider that gold, shown below on a daily chart of its rightful proxy, the SPDR Gold Shares ETF (GLD), has provided something of a nice pitch to swing at as it has acted very well since its pocket pivot buy point of nine trading days ago. We can see that this pocket pivot of nine days ago came about as the GLD moved up through its recent bottoming range and the 65-day exponential moving average. Over the past week the GLD has moved higher to re-take its 50-day moving average with buying volume picking up. Notice the volume dry-up on Friday of this past week as the GLD pulled back slightly but remained healthily above its 50-day moving average. And as gold moves higher I notice that a number of mining stocks, such as RGLD, GOLD, NEM, AUY, etc. are all moving higher as well, with some, like GOLD and NEM, moving to new all-time highs. In my view this confirms the move in gold as I expect it to make a reasonable attempt to clear its own all-time high over the next few weeks.

SPDR Gold Shares ETF (GLD) Gilmo Report Chart

Mining stocks in general tend to be big teasers when they break out as they generally fail to hold such breakouts. I’ve been watching mining stocks for a long time, wondering when the sharp rise in precious metals prices might lead to a big move in mining stocks similar to what we saw in the late 1980’s when stocks like Newmont Mining (NEM) and recent-IPO-at-the-time American Barrick (ABX) had huge price moves (see page 13 of my April 5, 2009 report in the Past Reports section of the website). So far, mining stocks have not had such a move, but I would certainly keep an eye on the miners, such as NEM, shown on a weekly chart below, which flashed a pocket pivot on Friday. If institutions find that they must begin to take seriously the positive effects of higher precious metals on the profit structure of mining companies then the “go to” stock may likely be NEM as the biggest player in the group, even though its fundamentals pale in comparison to Randgold Resources (GOLD), which recently broke out through the 115 price level.

Newmont Mining (NEM) Gilmo Report Chart

GOLD, which I show on a daily chart below from our friends at High Growth Stock Investor (www.highgrowthstock.com, ©2011, used by permission), broke out on Wednesday in what was not necessarily the prettiest breakout as it stalled slightly on above-average volume but held the new closing high. The next day it gapped higher to all-time highs and found support on Friday as it closed at the peak of the daily range. GOLD’s fundamentals are probably the most impressive of all the gold mining stocks, with massive 342% earnings growth on sales growth of 166.6%. GOLD is now showing a very sharp three-quarter, triple-digit earnings acceleration with three quarters of triple-digit sales growth, and earnings estimates over the next two quarters call for significant upside growth of 455.17% and 300%, respectively. As I already indicated, the easy way to play this breakout might be to buy it here using the 114-115 breakout level as a reference for a quick downside stop. While I think NEM is likely to find a lot of institutional money coming into it if a sustained move in gold stocks indeed pans out here, GOLD has the best fundamentals and chart position, given the recent breakout, in the gold group, so I would consider it the leader of the pack.

GOLD Gilmo Report Chart

Linkedin, Inc. (LNKD) flashed three pocket pivots over the past three weeks before announcing earnings on Thursday of this past week, and the pocket pivots were in fact clues of a favorable earnings announcement. The strong fundamental performance was overshadowed, however, by LNKD announcing a $100 million secondary stock offering. This sent the stock reeling to the downside after-hours following an initial upside blip. The stock traded down as far as the 77 level on Friiday before finding its feet and closing in the upper half of its daily trading range, as we see on the daily chart below. I would keep an eye on LNKD here as I think that once the secondary offering is priced the stock could try and push back up through its 50-day moving average, currently running through the 83 price level, roughly. Social networking will likely be an important space in any future market rallies, so I am watching for a possible shakeout here. LNKD got close to pulling this off on Friday, reversing back to the upside and trading as high as 85 and change before dipping slightly into the close, so keep a close eye on this one as the offering is completed.

  Linkedin, Inc. (LNKD) Gilmo Report Chart

In my GoView.com video of last weekend I discussed keeping an eye on Fusion I/O, Inc. (FIO) going into earnings on Wednesday of this past week, and the stock blew away estimates of 3 cents by coming in with 15 cents a share in earnings for the quarter, a 350% absolute increase. This sent the stock gapping up on Thursday morning on what initially looked like a buyable gap-up, but right after the open FIO retraced all the way back down to almost the 30 price level before turning back around and staging a pocket pivot breakout buy point at around the 35 price level on huge volume, as we see on the daily chart below. Conceptually I consider FIO a game-changer as a developer of technology that essentially uses flash memory to relocate process-critical data from centralized storage networks and bring it closer to where it is being utilized to increase network efficiency and speed. I like this breakout, and would be all over any pullback to the 34-35 price level following this very strong upside move. The cup base that FIO is coming out of is quite deep and v-shaped, so a small pullback from here would be considered normal and buyable.

Fusion I/O, Inc. (FIO) Gilmo Report Chart

Ulta Salon Cosmetics & Frgrances (ULTA) broke out of a short base on Friday after flashing a pocket pivot buy point four days earlier. This was likely helped along by Estee Lauder (EL), not shown, which announced earnings on Thursday and gapped up to all-time highs, flashing a buyable gap-up using the 111.57 intra-day low of Thursday as a downside stop. ULTA, however, is more in range with this breakout, and given the confirming strength in the group appears buyable here using the usual 7-8% of the top of this base at around the 72-73 price level as your downside stop. Retail stocks of many stripes are acting very well here, from DECK to TIF to JWN to cosmetics retailers like ULTA and EL, and so if the market is able to move higher this area has already identified itself as a potential leading group. Keep in mind, however, that ULTA has had a long price move since the early 2009 market lows, so it is anything but “fresh merchandise” here, but may still work in a continuing rally phase.

Ulta Salon Cosmetics & Frgrances (ULTA) Gilmo Report Chart

Another retailer acting well and one which I discussed in my report of last weekend is Under Armour, Inc. (UA), which staged a huge-volume breakout last week following earnings. So far, as we see on the daily chart below, UA is holding the breakout and its 10-day moving average quite well, and I would watch for a possible continuation pocket pivot buy point to emerge here if the stock is able to move up off the 10-day line. UA adds strength to the retail leadership argument. On Friday UA held the 10-day moving average in a down market with selling volume drying up, which looks constructive and in my view sets up a potential upside move from here. At the very least, UA should hold the 80 price level on this recent breakout, and at Friday’s close of 84.30 the stock is roughly within 5% of that breakout buy point level.

Under Armour, Inc. (UA) Gilmo Report Chart

More constructive action is seen in the retail space in the form of retail restaurant player Panera Bread Co. (PNRA) staging a massive gap-up last week and then holding tight this week in what is a typical “short stroke” formation showing a huge weekly upside move on huge volume the prior week. This was followed by a fairly tight weekly range and close at the peak of the weekly range this past week. I was working at William O’Neil + Co., Inc. when we observed the first “short stroke” formation when Research in Motion (RIMM) gapped up out of a base in December of 2003, and so I am quite familiar with the rationale behind it. In my view, PNRA meets the definition quite well, and so this pattern becomes potentially buyable using the 127.55 intra-day low of the buyable gap-up day seven days ago as your downside guide for a stop, about 6% lower from Friday’s close. Volume dried up sharply going into the end of the week this past week as the stock held tight, so I would not be surprised if the stock moved higher from here.

Panera Bread Co. (PNRA) Gilmo Report Chart

Medical-related stocks like Intuitive Surgical, Inc. (ISRG) and Questcor Pharmaceuticals (QCOR) continue to act well although they are not in buyable positions (see my notes on these further below). I would also say that Biogen Idec (BIIB), which staged a buyable gap-up nine days ago, is also holding up reasonably well despite drifting just below the 114.28 intra-day low of the gap-up day of nine days. One could allow BIIB a little bit of “porosity” around that 114.28 level, and the fact that it closed at 113.49 on Friday keeps it within reasonable range of that gap-up move. As long as the stock can hold the 109-110 breakout price level it is probably okay, but I would like to see some sort of confirming pocket pivot type move take it back above its 10-day moving average, currently running through the 114.06 price level, as a confirming follow-up to the strength shown on the gap-up of nine days ago. I think it is possible even to buy into this pullback with the idea of using the 109-110 area as a very quick 3-4% downside stop if the stock fails to hold the breakout. BIIB’s new drug for multiple sclerosis is a potential blockbuster, so the story here remains mostly “on the come” as the drug is prepared for marketing.

Biogen Idec (BIIB) Gilmo Report Chart

Some quick notes on the long ideas I’ve discussed in recent weeks:

CMG – holding above its pocket pivot buy point of two weeks, but still reluctant to make a move into new high price ground. Otherwise it is just moving back and forth in a two-week consolidation following its strong pocket pivot move on earnings and holding along the 10-day moving average, which could serve as a launching point for a second, buyable pocket pivot buy point in the pattern.

LULU – no follow-through from last Thursday’s pocket pivot buy point but still holding above 50-day moving average. Stock is holding along its 10-day moving average, so watch for any pocket pivot type moves coming off the 10-day line.

ISRG – still holding above buyable gap-up of two weeks ago and tracking upward along 10-day moving average. Watch for a possible continuation pocket pivot developing along the 10-day line.

MA – pulling back down to 360 level and Thursday’s gap-up breakout level. Somewhat mushy.

QCOR – holding above buyable gap-up of eight trading days ago and holding well above its 10-day moving average. Stock is slightly extended above its 10-day moving average, so it would have to pull back to the 10-day line if it were to flash any kind of continuation pocket pivot from here.

V – stock has reversed after a nice pocket pivot breakout buy point of six days and is back in its prior trading range in which it has been stuck over the past four weeks.

Despite the market’s choppy action and crazy up/down gap moves as the futures fluctuate widely overnight, constructive action among a broadening group of potential leaders provides an improving underlying tone to the market. But as long as the market is unable to clear current resistance levels at the 200-day moving average, for instance, on the NASDAQ Composite and S&P 500 Indexes, these stocks may simply continue to base-build. Thus while they don’t necessarily have to start rocketing to the upside post haste, they should be monitored as constructively acting stocks in an otherwise choppy, mushy and uncertain market environment when it comes to the action of the major market indexes over the past three weeks. On the short side of the market I am seeing very little hit my screens, if at all. Only when I combine this with the action that is apparent in weekly charts of the major indexes (blocking out the daily “news noise” that plagues this market), do we gain a glimpse of the market’s underlying desire to move higher.

In my previous report I asked the question as to what underlying conditions could drive a continued year-end rally for stocks. I tend to think that, at least for now, any crisis conditions in Europe or in the U.S. will simply engender more money-printing. This in turn will drive the price of gold higher as an alternative currency, but as I’ve suggested in previous reports and in recent radio interviews this past week, there is always the potential for stocks to be viewed as stores of wealth or types of alternative currencies as the paper of stock certificates may be considered more worthwhile to hold in lieu of the paper of fiat currencies. That is one theme that could drive a continued market rally. Another one is the market beginning to sense a significant change in government and an inflection point back to relatively and drastically more favorable policies towards business and capital formation. When one is in the midst of a raging blizzard, even a change to just gray skies may be enough of an inflection point to drive a big move in stock prices.

My focus here is not to be necessarily bullish or bearish, but to operate solely on the evidence that the market is presenting, and to try and figure out where and in which direction the “line of least resistance” lies. I can see some underlying pressure beginning to build for the long side in the form of more bases forming among many different stocks as well as more breakouts. While most breakouts have not led to any significant upside moves, the reason for this is likely a general market environment that is still somewhat mushy and volatile. These, however, are almost always the first percolating clues of where the leadership may lie once the lid comes off the market, however that materializes. Sometimes it occurs to me that maybe, just maybe, if Greece were allowed to default, and maybe Italy too, and a few banks were allowed to go under while governments sought to protect depositors instead of bailing out their bankster friends, stocks might just rally. Stocks know that the virtuous cycle of creation of destruction is real, and without allowing the destruction side of the cycle to run its course, the creation side is thereby muted or kept to the sidelines. Conversely, by letting the destruction side of the cycle now run its course, as it should have been allowed to a couple of years ago, the market will sense an impending return to the creation side of the cycle, because this is what is right and necessary for economic growth on a most fundamental and core basis.

Pehaps this is wistful and wishful thinking on my part, but the market is always about possiblities. In my view, this is one possibility for the markets as we move into the final two months of 2011 and into 2012, a year that may be pivotal for governments and economies around the globe, and there is some supporting evidence in the price/volume action of certain stocks. Gold remains very playable here as I see it, so that remains one area where a line of least resistance has been pierced to the upside with the pocket pivot buy point of nine days ago. Certain stocks, particularly in the realm of “new merchandise” such as FIO, for example, seem to be showing strong signs of life, while the short side does not seem to offer many strong set-ups currently. That could, of course, change over the next few days, but for now I’m watching this market carefully with an open mind, and simply looking for what I believe are fat pitches to swing at without worrying about whether I am “bullish” or “bearish.” Stay tuned.

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 position in AGQ, DGP, FIO, and GLD, though positions are subject to change at any time and without notice.

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