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TECHNICAL ANALYSIS: CONTINUATION PATTERNS

Technical chart analysis has a widely debated reputation as a forecast tool for price behavior. Many, including this writer, believe it can serve as a critically important tool in combination with fundamental analysis. The study of a company’s product offerings, cost structure, array of customers, trend for product demand, debt burden, and financial balance sheet all contribute toward its fundamentals. Likewise, the study of a commodity or currency involves numerous key factors intimately related to their supply and demand. On the other side of the analytic workshop is the chart room, where price movement over time is examined for defined patterns. It is my opinion that the best of forecasts employ both methods. Two weeks ago several reversal patterns were displayed and discussed. Such patterns can be dramatic. Here, let’s review continuation patterns. What makes chart analysis more of a challenge is the integration of reversals, continuations, and even hesitations into a steady stream of patterns in need of identification and recognition.

For a nice brief review of many crucial patterns, see the free website by my favorite charting tool at StockCharts. The Technical Analysis Guide is worth saving as a favorite site.

Regardless of the precise laws governing motion, the paths of price behavior over time reveal much. When you step back and observe the pattern, it can reveal much. If a short-term chart is not clear, back off to a weekly chart for more clarity. A review of some frequently appearing chart patterns might be valuable. Many advocates of technical analysis believe that imminent fundamental dynamics, such as changes to profitability or dilution to shares or introduction of new products, are all factored into the chart pattern. Correspondingly, advocates believe the commodity charts incorporate the dynamics behind changes to supply, either from discoveries of materials or from government inflation, and the dynamics behind changes to demand, either from industrial growth or from economic expansion. This describes my view. Too often, a chart will indicate changes which are not evident in the underlying fundamentals until a few weeks pass. Then what the chart told seems obvious, but after the fact. My main shtick criticism of critics to chart analysis is that they dismiss the correct early warnings and their methods, then later, they say “it was obvious” in a truly unethical manner which brings their personal integrity into question. In other words, they did not understand or appreciate the methods before or after some sense of proof was offered.

The debate on the value of technical analysis might extend from “left brain” and “right brain” factors. Fundamental analysis derives from a logical and numerical defense of value, reviewing numbers and percentages, the province of the left (logical) brain. Technical analysis derives from pattern recognition and special reasoning, the province of the right (creative) brain. T/A detractors might lack a developed right brain, or worse, be absent both hemispheres.

Nothing is foolproof. For certain, chart analysis can be a valuable tool for investors, both professional and individual. Almost every major mutual fund house employs a highly revered, highly respected, and highly paid staff of shared technical analysts who work “the chart room.” Fidelity surely did during a brief consulting stay of mine. The moving averages displayed are 50-week and 50-day types, visible in blue.

UPCHANNEL

No rising price trend proceeds in a straight line. Even when an item moves generally upward in price, it will tend to jump around, enjoy some brief momentum, and bounce off invisible barriers when the price gets a little out of whack on the high side or low side. If an item trends upward in a peaceful non-volatile fashion, it might rise within the bounds of an upchannel. An upchannel permits a trend to remain at work, variability to be allowed, while buyers and sellers battle it out. Take for instance the price of gold over the past three years. One month ago, a Monday essay outlined Reasons Why Gold Will Rise, a revisit of the theme, which might justify many of the fundamentals behind the long-term gold bull market. While it has not enjoyed the upside explosion many expected to $500, it has kept within the upper rail and lower rail of a channel which rises over time. Some adept traders buy near the lower rail and sell at the upper rail, only to seek their next purchase of a watched item near another channel lower rail.

Notice that despite the apparent damage levied on the gold market this past spring, it found legs of support at the channel lower rail, which some adept analysts anticipated. Gold’s fundamentals had NOT changed. In fact, even though the Federal Reserve has begun a new tightening cycle, even though long-term rates have begun to jump upward, consumer price inflation has also awoken and risen. Negative real rates might actually run deeper negative, which this analyst expects, but mainstream analysts do not expect. So the uptrend channel should be maintained. An added nuance is worth pointing out. Less extreme mid-trends on the upside and downside are evident, shown with weaker bold lines. A less extreme upchannel has taken over in recent months. A break below the lower trendline, and below the 50-week moving average (in blue) would signal an eventual move toward the 380 to 385 range. The critical area is now 395-400 to be defended. If a breakdown indeed happens, it would probably coincide with a USDollar bounce.

In the meantime, a narrower uptrend channel is evident, one which will be harder to remain inside. It seems we move from one end of the channel to the other in a short span of time. The current range and channel will not prevail for long. My position is that gold will break through the lower barrier. Notice the three successive peaks, each at a lower price. The January 2004 high was 428, in April it was at 423, and recently in August at 415.

LESS AGGRESSIVE UPTREND REPLACEMENT

When a new trend benefits from public discovery, embraced by wide acceptance and broad participation, funded by easy money, an uptrend can get out of control from being too aggressive. It cannot sustain itself. Gravity takes hold and pulls it down. Greed loses out. Smart guys seize the profit offered. That might have happened with the unhedged gold and precious metals miner stocks in the last two years, as seen through the HUI goldbug index. When the uptrend channel breaks down and is violated, the damage can be severe to individual stocks. However, in the case of gold and its miners, very little has changed in the underlying fundamental story. A long-term uptrend is still justified, but perhaps not one with such sharp price appreciation and aggressive tone. A disturbance surely occurs, but the price behavior finds its footing. A new stability is found, wherein the new uptrend channel has a smaller growth rate and more gradual upward slope. It is less subject to animal spirits, and more prone to be sustainable over time.

BULLISH TRIANGLE

Upward pressure can be relentless at times. Resistance can also be stalwart. In the case of the stock price for Newmont Mining, the 42.5 level not only provided resistance from previous turns in the early months of 2004, but the 200-day moving average pressed flat at 42.5 also. An uptrend is readily apparent in a multi-year weekly chart, which offered nice support from below. The battle of topside resistance and uptrend support created a nice bullish triangle, sometimes called an ascending triangle.

Triangles can make available to the analyst a reliable target for the price to attain, after the breakout, if it indeed does break out. The target is as high above the breakout level as the impulse low was below that level. Take the height of 7 points from the flat top to the impulse low. Now add those same 7 points to the resistance at 42.5 to get a target of 49.5 for future movement. We will see it this indication comes to be. A general rule of thumb is that the breakout tends to occur two thirds of the way from the identifying impulse low along the way toward the vertex of the triangle. The rule held in this case. The full triangle ranges from mid-April to early October, with a 2/3 mark roughly sometime in August, which came to pass. Did the break out occur because the chart said it would then? Did it break out because the fundamentals asserted themselves? Who knows? Who cares? Yet, the debate rages on, in seemingly useless futility and waste of time. These are tools. With a trapped driver in a car, do we argue whether a giant crowbar or sawzall is a better tool? They are both useful, just like technical analysis.

The same bullish triangle is evident in the above HUI chart. Newmont makes for the largest single component to the HUI, so similarity is no surprise. The unhedged goldbug index also broke north of 200, and like the NEM chart did with 42.5, moved above the flat top 2/3 of the way towards the triangle vertex. What’s more, it also registered a return visit to the breakout. Some call it the “springboard” used to resume the upward path.

Those with a keen eye can notice in the above gold chart in the Upchannel section, another bullish triangle. In the first half of 2003, a triangle formed with a 370 flat top and an impulse low of 320. Its uptrend was defended with a midsummer turn at 345. It broke out in September 2003, again 2/3 of the way toward the vertex, and did a revisit with another springboard. The 420 target was reached, on cue. In fact, it was retested with a failure, only to be followed by yet another revisit to the breakout at 370.

ELLIOTT WAVE TRIPLE STEP

A time-honored pattern for ground-breaking movement where support and resistance from recent months seems not so relevant is the Elliott Wave. The pattern helps to govern movement on major breakouts where past history cannot offer guidance. Much dispute has arisen over its identification, usage, and forecasting potential. Displays of its characteristic wave patterns do not occur frequently. So when they do, much ballyhoo ensues. Rather than to defend its validity, to argue its central elegant points, and to become embroiled in debate, take a look for yourself. The only aspect of this particular case which departs from many previous historical examples is that the middle wave typically is larger than the first and third. Here, with the USDollar in the DXY index, the first and second legs are of equal length. Forces recognized during the first leg were possibly too compelling, with a growing trade gap, an uncompetitive export market, a monstrous money printing operation adding to currency supply, and a weakened and absurdly imbalanced economy aggravated by job outsourcing. Note the characteristic large correction after the middle wave. Note the fight at 100 parity had no substance to it, only a battle at a psychological point. Typically, after a long protracted triple-leg decline, the correction will play itself out in a double-leg up in a counter-trend correction. So far, that seems to be what is happening, except for frustration in the second counter upleg. Will improving economic fundamentals confirm a DXY rise past the 92 prior peak? Will the 50-week moving average be overcome convincingly to the upside? Will central banks collude to help the conclusion?

The psychology behind the Elliott Wave is equally fascinating. The first leg has the least participation. It is led by those who see something big coming. Dissenting opinion is broadly stated in the investment community, only to interrupt some players from entry. Thus, its correction is small, as profit taking is not so substantial. Given the growing acceptance, many new players join after the minor selloff with a beneficial entry point. Then comes the awakening, as the public begins to notice, the press & media finally recognize the story, and momentum players pile on bigtime. The second leg has greater participation. It is usually the largest leg with hefty profits and great price strides. Therefore, the correction which follows tends to be substantial and possibly frightening. The theory dictates that the second correction cannot go beyond the extensions made by the first leg. Finally, the trend resumes, nothing has changed on solid fundamentals, and a blowoff top occurs to end the sequence. In many cases, the powerful enormous change in price does much to rectify the price imbalances initially begging for solution. A two-leg correction follows, as the trend might be rendered finished. This is NOT the case with the USDollar, whose fundamentals have actually worsened. See my summer 2003 article “Vicious Circles and the USDollar” for a better understanding of why lower US$ exchange rates breed new problems which undermine the fundamentals further, and produce yet more declines. The vicious circle will not stop until a monetary crisis unfolds. The vicious circles involve economic factors, financial investments, banking practices, defense of the petro-dollar, Asian trade recycling, and the inverse correlation with gold.

The mega-question in the gold camp these days focuses upon whether, as is typical of Elliott Waves, a double impulse correction will take place now that wave #3 has completed. Typically, three legs down and two counter-trend legs back up. We have seen the first correction high in May. The 50-week moving average has been penetrated, although hardly in convincing fashion. The second upleg cannot seem to find enough strength to surpass the 92 May high. The double Elliott upward impulse has not reached completion, usually to a level not to exceed the second correction, and might not occur at all. A US Economic recovery would surely justify a second sizeable bounce in the USDollar currency. The lack of job creation makes a lie out of government GDP growth figures. Claimed growth derives from understated price inflation and hedonic adjustments, to make a flat economy appear growing. The arrival of widespread price inflation, horrendous trade gaps, and uncontrolled federal deficits all work to limit any upward movement in our crippled currency. These nagging negatives are the backbone behind the US$ weakness, and have not been rectified in any way whatsoever.

We await the outcome. Resolution might be taking so long partly because the typical pattern has been disrupted, and upward progress from technically (chart) driven demand must be neutralized over time. Both fundamental weakness and technical weakness point to upcoming declines in the DXY index. See the Adam Hamilton article on “The USDollar Bear Intact” for a fine overall analysis. The USDollar has no business rising here. If it does, a combination of economic reporting deception (phony recovery), hedge fund repayment of US$-based loans (cash margin calls), and sheer desire by central banks (interventions) for world reserve currency health will rule the day

NEWS TIDBITS

World oil prices shot higher as companies operating in the Gulf of Mexico braced for output disruptions in the face of powerful Hurricane Ivan. Light crude jumped over a dollar per barrel. Ivan, a rare category 5 hurricane, is expected to cross the western edge of Cuba on Monday and enter the Gulf of Mexico on Tuesday. It has veered west from its previous path toward Florida, and is now forecasted to hit the US coast near Biloxi and Mobile. The Gulf is home to about 25% of US oil & gas output. Shell Oil said it had shut 270,000 bpd of oil production in the eastern Gulf and would evacuate workers from the central Gulf by Wednesday. OPEC ministers may resist calls to raise oil output quotas much, if at all, when they meet this week for fear of turning a decline from record prices into a rout. Cartel delegates say the assumption of legitimized moves in existing quotas to higher official supply limits by a hefty 6% at Wednesday's meeting could prove wide of the mark. Some expectations had been for OPEC to lift formal production quotas from 26 million barrels a day to match actual supply now that is running at least 1.5 million bpd higher, to help drag prices below $40 a barrel. The average US retail price of gasoline fell two cents over the last two weeks to about $1.86 a gallon, restoring a trend of declines after a modest increase late last month, according to the nationwide Lundberg survey of about 7000 gas stations released on Sunday.

US Airways plans to slash costs under its second bankruptcy in the last 25 months, in a bid to become more like the discount airlines that threaten its survival. Soaring fuel costs and weak sales amidst ferocious competition from low-cost rivals are claimed to be the root of its problems. It has failed in a bid to secure cost-concessions from labor unions, some of which are also key shareholders. The main casualty of airline financial distress has been pension funds and programs. In my view, the hub service model which reaches every major city is under severe scrutiny. Wal-Mart maintained its September sales forecast and said back-to-school demand picked up for key categories including electronics and clothing after a sluggish start. The world's biggest retailer said it still expects a 2% to 4% increase in September sales at its US stores open at least a year. The PIMCO mutual fund group has agreed to pay $50 million to settle fraud charges involving improper rapid dealing in mutual fund shares. In a case focused on "market timing," the SEC said PIMCO will pay a penalty of $40 million and disgorge $10 million in ill-gotten gains, without admitting or denying any wrongdoing, as is customary in SEC legal settlements.

A huge explosion in North Korea last week was a deliberate blast to pave the way for a hydro-electric dam, Pyongyang said. Washington and Seoul have said the explosion was unlikely to have been a nuclear weapons test. South Korean media said an accident at an underground munitions depot or a weapons factory was a likely explanation for possibly two blasts. A British minister visiting Pyongyang said that the North Korean authorities had agreed to allow foreign envoys to visit the scene and see for themselves. South Korea's financial markets, which can react sharply to developments in the North, had ignored the blast reports, which came as diplomats were seeking to persuade Pyongyang to return this month to six-party talks on its nuclear weapons programs.

More explosions at Iraqi insurgent strongholds. More troop deaths, more civilian deaths, no resolution, no peace, but plenty of inroads to democracy. Peace is elusive. Surely, premise for war is hotly debated. Do we really know what the original goals were? Are they resisting freedom, or our occupation, or control of their oil supplies? Where does their oil revenue go? Are US taxpayers funding the reconstruction of Iraq, and not their substantial oil revenue? These are legitimate questions for supporters and critics. Leaders provide no answers, as the soldier death count surpassed 1000.

For the first time in over a decade, no American man or woman took part in the US Open tennis finals. Swiss Roger Federer humiliated Aussie Lleyton Hewitt for the men’s title, with two 6-0 individual set victories. Russian Svetlana Kuznetsova defeated Russian Elena Dementieva for the women’s title. The Russian women have arrived in force, with a certain follow through since darling Maria Sharapova made her presence known at Wimbledon. Pro football launched over the weekend. It was a weekend of big plays and key player stories. Why the New York Giants would want a draconian boot camp drill instructor Tom Coughlin as head coach is beyond me. Expect a mutiny by veteran players in a matter of weeks. Baseball pennant races continue one of the closest finishes in history. The Boston RedSox have picked up over 10 games against the NYYankees in the last month. Seattle’s Ichiro pursues George Sisler’s longstanding record for hits in a single season. Movie box office receipts remain tame. “Resident Evil” led with $23.7 million, followed by “Cellular” at $10.6M and “Without a Paddle” at $4.6M.

TODAY’S MARKET

Today the Dow Jones Industrials wrapped up at 10,315 (+2), S&P at 1126 (+1.9), Nasdaq at 1916 (+16), TENS yield 4.151% (-2.9 bpt). Currencies closed with Euro at 122.28 (+0.79), JYen at 90.74 (-0.82), Can$ at 76.91 (+0.72). Metals finished with gold at 404.5 (+2.0), silver at 618.3 (+6.7), copper at 128.50 (+0.35). Energy ended with crude oil at 43.88 (+1.07) with yet another hurricane threatening the Gulf of Mexico, natural gas at 486.0 (+29.0), unleaded gasoline at 119.90 (+3.48). Prices are at major futures contracts.

Jim Willie CB

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