Written by Jim Welsh
Macro Tides Weekly Technical Review 13 May 2019
Gold Rallies as Expected
As discussed last week the current decline in Gold from its February peak at $1347 is wave (e) of the triangle that has been forming since Gold topped in July 2016 at $1375. Wave (e) of the triangle ‘should’ take a down, up, down pattern from $1347. After peaking at $1347 Gold fell $81 to a low of $1266 on April 23 which is likely wave a of wave (e).
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Wave b of (e) was expected to retrace a portion of the $81 drop for wave a of (e) as covered last week:
“A 38.6% retracement would lift Gold to $1297, or to $1307 if it retraces 50%, and $1316 for 61.8%.”
On May 13 Gold rallied up to $1301.33. Since wave b of (e) can be expected to be an up, down, up pattern, the rally to today’s high is likely to be followed by a modest pullback and then another rally. Given the length of the rally from $1266 to $1301, the odds that Gold can reach the 61.8% retracement have increased. This would allow Gold to trade up to $1316 or so before wave b of (e) is complete. Gold bounced to $1324 on March 25 and $1310 on April 10, so a high near $1316 would split the difference.
Click on any chart below for large image.
Once wave b of (e) is finished Gold could fall $81 which would allow wave c of (e) and wave a of (e) to be equal. If Gold does top at $1316, the subsequent decline would bring Gold down to $1235. Gold rallied $187 after bottoming at $1160 on August 16 for Wave (d) of the triangle. If Wave (e) retraces 50% of the $187 rally for Wave (d), Gold would fall to $1253 and to $1231 if Wave (e) retraces 61.8%.
The Gold ETF (GLD) would fall to $117.13 if it retraces 50% of the Wave (d) rally from $111.06 to $127.21 and to $117.23 if Gold retraces 61.8%.
Gold Stocks
As noted last week, GDX tested its January low and managed to record a slight positive divergence on its RSI:
“GDX tested and slightly exceeded the lows near $20.24 in late January dropping to an intra-day low of $20.14 on May 2 (red trend line). GDX did manage to record a slight RSI positive divergence, which could help GDX to rally to $21.10 or higher in coming days.”
GDX jumped to $20.99 on May 8 and then fell to $20.26 on May 10, only to rally to $20.99 on May 13 after Gold traded up to $1301. If Gold continues to follow the script and pulls back a bit in coming days before pushing up to $1316.00, GDX could slump before it rallies above $21.10 and possibly up to $21.43 which was the intra-day high on April 26.
The challenge in forecasting a path for GDX is the changing level of relative strength it has displayed in recent months. If GDX’s relative strength improves it could not only test $21.43 but exceed that level, or fail to reach it if the relative strength continues to weaken as it has in recent weeks. If Gold follows the script described – a rally to near $1316 and then a subsequent decline of $81 to $1235 – Gold stocks could prove vulnerable to a deeper correction. Its seems less likely that the relative strength of the Gold stocks would improve as Gold loses more than 6% of its value and falls below the low of $1266.
If the relative strength of the Gold stocks remains poor, which seems like the more likely outcome, GDX could easily fall to $19.50 (black horizontal trend line), and in a worse case, drop to $18.50. In the April 8 WTR I recommended a 33% position if GDX fell below $21.60, and recommended increasing the position to 66% if GDX traded below $20.60. I am not comfortable holding this large of a position if GDX has the potential to fall under $19.00. If Gold does manage to rally to near $1300 or higher, GDX should rally and selling into that strength makes sense. Sell half of the position at $21.05.
Treasury Bonds
A majority of investors still believe the Federal Reserve will cut the federal funds rate before the end of the year, in part based on inflation being below the Fed’s 2.0% target. The break down in trade talks with China reinforces this view since economic growth is likely to be negatively impacted if tariffs continue to be ramped higher and no trade deal materializes. No one, including members of the FOMC, knows what path the trade talks will take. Given the volatility of the process the FOMC will wait until economic data confirms the U.S. economy is softening, since there still could be a trade deal within 60 or 90 days.
So until the trade talks collapse completely and weakness in the U.S. is confirmed, the FOMC will be patient. The market liked the idea of the FOMC being patient about raising rates but may not be so enthused if the FOMC doesn’t respond to the first sign of slowing. This is a volatile environment and the FOMC wants clarity.
For months most investors expected there would be a trade deal and the breakdown is forcing everyone to reassess their view. As discussed last week:
“Much depends on trade negotiations which could either provide the global and U.S. economy a boost, or cause a quick sharp contraction if tariffs are increased by the U.S. and China.”
According to JP Morgan bond investors are holding the largest Net Long position since mid 2016. This suggests that the next big move in interest rates is not down but up. The upset caused by the new tariffs is providing Treasury bonds a lift which was expected based on the chart patterns in Treasury bonds and the Treasury bond ETF (TLT).
“The chart below suggests that TLT could still rally to near the high of $126.69 in coming weeks, or exceed it slightly for wave 5 from the early March low. If it does, the RSI would likely record a negative divergence and provide technical confirmation that a high is developing.”
On May 13 TLT rallied to $125.99 and appears ready to exceed $126.69 in coming weeks.
The weekly chart suggests TLT may rally above the September 2017 high of $129.56. From the November low of $111.90 TLT moved up $11.96 and an equal rally from the February low of $118.64 would target $130.60. TLT rallied $8.05 from the low in February and an equal rally from the April low of $122.11 would target $130.16.
Once the current rally is complete TLT may finish the corrective rally from the low in March 2017 for Wave (B) in red. This corrective rally would have taken the form of an a, b, c in green. If this pattern analysis is correct, TLT has the potential to decline below $105.00 by early 2020 for Wave (C), if Wave (C) is equal to Wave (A) (143.62-116.49 = 27.13).
The 30-year Treasury yield is likely to drop under 2.77% and could breach 2.60% if TLT does rally to $130.00 or higher.
The 10-year Treasury yield is likely to drop under 2.30% and could breach 2.20% if TLT does rally to $130.00 or higher.
From the momentum low in December 2016, TLT rallied until early September 2017 or just over 8 months. A comparable rally in time from the low in Treasury bond prices on October 5 would target mid June for the next high in Treasury bond prices. If all the pieces fall into place, a good short trade may develop in Treasury bonds. After the peak in July 2016 TLT lost -18.8% of its value in less than 7 months in Wave (A) in red (TLT weekly chart above). Something similar could be setting up before the end of June.
Dollar
After peaking at 98.33 on April 25, the Dollar peeled off a quick 1.18 points falling to 97.15 on May 1. After the FOMC meeting on May 1, the Dollar spiked to 98.10 and then swooned. An equal decline of 1.18 points would have targeted a low at 96.92. On May 13 the Dollar fell to 97.02 after China announced retaliatory tariffs before rebounding to 97.35. The price action suggests the Dollar may have completed an a, b, c correction after hitting 98.33. If correct, the next move should be up. As noted last week:
“A close below 96.70 is needed since it would take out the prior low, so until the Dollar breaks down one has to respect the resilience.”
Since reaching 97.71 in mid November, the Dollar has traded in a choppy pattern which has made reading its chart difficult. Although the Dollar could still push up to 100.00, sentiment and positioning argue strongly that an intermediate high in the Dollar is near. Although the Dollar and Gold often don’t trade inversely a push higher in the Dollar may be one of the factors that contributes to Gold dropping $81 after it reaches $1316.
Stocks
I ended last week’s section on the S&P 500 with this cautionary assessment:
“The takeaway is the S&P 500 is nearing an inflection point based on sentiment, its price pattern, and the loss of upside momentum. For conservative investors it’s time to become more defensive if the S&P 500 rallies above 2954 or closes below 2870. For aggressive investors it’s too early to go short since we need to see more evidence of a top. Although we didn’t get short at the highs in September we did get short when the S&P 500 rallied up to 2800 in early November. When taking a short position, I would rather miss the top by a little if that patience is rewarded with more assurance that a larger decline is coming.”
Sometimes the 7 market gods are a tailwind and sometimes not so much. On May 9 the S&P 500 closed at 2870.72 after trading down to intra-day low of 2836.40. In recent weeks I‘ve tried to convey why the market was showing signs of weakening. In the April 22 WTR I wrote:
“Although the NASDAQ 100 recorded a new all time closing high on April 22, the 21 day average of Advances minus Declines was below 0! (red arrow).”
On April 18 (65-81) and April 22 (47-68) the number of stocks making a new 52 week low outnumbered the number of new 52 week highs. It is rare and unhealthy for a market average to be making a new all time high while there are more stocks recording new 52 week lows than highs. As discussed there is accumulating evidence that the rally is running out of gas. The final piece of this puzzle will be provided when the NASDAQ 100 and S&P 500 break down below their rising trend lines or close below a prior reaction low. For the NASDAQ 100 that would be accomplished with a close below 7580 and 2870 for the S&P 500. As long as these levels hold, the small number of stocks leading the charge higher can continue to carry the day.”
Although the S&P 500 closed above 2870 on May 9 and May 10, it did close below the blue trend line on May 7.
In the April 29 WTR I discussed why the divergence between the major market averages was not a healthy sign:
“The S&P 500 pushed to a new closing high and a new intra-day all time high on April 29, along with the NASDAQ Composite and NASDAQ 100. The New York Composite Index is -1.7% below its September 2018 high and -4.4% under its January 2018 all time high. The Russell 2000 is -7.9% below its all time high while the DJ Industrial average is -1.2% short and the Transports are -4.1%. The fragmentation between the major market averages is not a sign of strength.”
In the April 29 WTR I noted that sentiment had become too optimistic as measured by the Call / Put Ratio:
“The Call / Put ratio suggests the market is in the Zip Code of an approaching intermediate high. The C/P ratio is the highest it’s been since last September, June, and December 2017. As noted, the technical health of the market is stronger than in September so a big decline is not likely just yet. More likely is a pullback similar to the dip of -3.5% after the short term high in June 2018.”
At the intra-day low of 2825 on May 10 the S&P 500 was -4.3% below its intra-day high of 2954, and -2.6% below its closing high of 2946 on May 9.
After barely closing above 2870 on May 9, the S&P 500 closed at 2811 on May 13, and the NASDAQ 100 at 7324 after closing at 7582 on May 9 after trading as low as 7472. Now what?
The major market averages are now modestly oversold as measured by their RSI, with the S&P 500’s RSI at 31.2, NASADAQ 100 29.2, DJ Industrials 28.3, and the Russell 2000 34.9. The low on May 13 for the S&P 500 was 2801 which is a significant area that marked highs in October, November, and December last year. After breaking out above this level of resistance this should provide support. The range of support is 2780 up to 2815 which the S&P 500 has already violated.
The low today tagged a rising black trend line that connects the short term intra-day trading lows in October and November and the low on March 7. The S&P 500 effectively closed on the black horizontal trend line connecting the retracement rally highs in October, November, and December. It is important that this zone of support hold in the short term. Failure to hold above 2780 could be followed by a quick drop to 2650.
The Welsh Indicator combines the Call / Put Ratio with the Trading Index and closed comfortably below 1.0 on May 13, as noted by the green arrows.
Readings below 1.0 have marked at least a short term trading low which suggests the S&P could bounce to 2875 in coming days, just as it bounced in October and November after reaching chart support at 2650 – 2600.
The 10 day moving average of the Trading Index closed above 1.3 on May 13 which indicates selling pressure has reached a short term crescendo and is supportive of a near term rally.
The spark for a rally could come if / when Treasury Secretary Mnuchin announces a specific date for a resumption of trade talks in the next few days. On May 10 the S&P 500 rallied 68 points in 3 hours after Mnuchin said talks had been productive, even though China’s trade Minister had left less than 24 hours after arriving in Washington D.C. The willingness of market participants to grasp at any straw has been remarkable and suggests the market could rally again when a specific date is announced.
If you didn’t become more defensive last week I would recommend selling into a rally if the S&P 500 does manage to rally above 2870 in the next few days. Although support is likely to hold in the short term, the market is not oversold based on its internals.
In recent weeks I’ve noted that the 21 day average of Advances minus Declines was diverging badly even as the S&P 500 recorded a new all time high. From the April 29 WTR:
“Despite the new high by the S&P 500, internal strength as measured by the 21 day average of Advances minus Declines has continued to weaken (blue arrows). This confirms what the divergences between the market averages indicate: Fewer and fewer stocks are lifting the S&P 500 higher, while the majority of stocks tread water or fade.”
Although the S&P 500 has fallen by more than 4% the 21 day average of Advances minus Declines is not even close to being oversold. This suggests that the risk of the S&P 500 falling below 2780 in coming weeks (if not days) is relatively high, which is why selling into a bounce makes sense. Will Halloween come early this year? This is from the April 22 WTR:
“Given the way the market has rallied since the December low and the divergences discussed between the major market averages and the increased concentration in the mega cap stocks, the potential that the current rally will be followed by a decline to test the December low cannot be entirely dismissed. At a minimum a decline that brings the S&P 500 below 2700 is likely before Halloween.”
In the April 29 WTR I noted that the Russell 2000 posted its highest close since October but its RSI was far below where it was in October (blue arrow):
“This raises the stakes a bit and the Russell 2000 needs to follow through in the next few days or its going to look ugly. I think it will rally some more but not enough to erase the huge divergence in its RSI.”
In the May 6 WTR I discussed what it would take to negate the breakout in the Russell 2000:
“The Russell did follow through and closed above 1600 convincingly on May 3. After opening down by more than 1.5% on May 6 in response to the China tariff news, the Russell 2000 reversed and managed to close up slightly on the day. Despite the breakout, the RSI is still diverging badly. A close below the May 6 low of 1588.00 would likely negate the breakout.”
The Russell 2000 closed at 1582.31 on May 7 thereby negating the breakout, and closed at 1523 on May 13.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line on February 26, as it did on March 30, 2016. This increases the probability that a bull market has been confirmed. Prior to a decline the MTI would be expected to at least flatten out as it did in September. However, the reversal in January 2018 was so quick the MTI effectively topped as the S&P 500 peaked.
Last week I noted that the MTI had flattened out as the ascent in the S&P 500 has slowed which provides another warning that the S&P 500 is more at risk for a pullback. The absolute level of the MTI suggests the S&P 500 is likely to rally after any short term dip. The key is the S&P 500 holding above important support at 2780.
Disclosure
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
