Justin Smyth's Contributions

Sector rotation has been the name of the game to start 2012 for the stock market. The lagging sectors from 2011, including the financials, homebuilders, industrials, and materials, have been the leading sectors to start the year. This is exactly what the market needed to start establishing a more healthy structure.

Of the legions of investors who are welcoming a fresh start to the year after the choppy and directionless market of 2011, perhaps gold stock investors are the most eager. Gold stocks had a volatile year last year with no progress made on the upside. The HUI Gold Bugs Index was rangebound between 500 and 600 for the whole year, with 3 failed breakouts above 600.

One of the beauties of trend following is ignoring the constant swirl of noise that surrounds the market. Charts don’t lie, and they don’t have opinions. By pouring through a wide variety of charts, from the major market indexes, to commodities, bonds, and foreign markets, you can develop an overall feel for what is going on in the markets.

Back in July I wrote an article discussing the fact that the Euro had failed so far to come under pressure during this wave of the European debt crisis. In fact it was still in a technical uptrend since bottoming in 2010 after the first wave of the Euro crisis.

The S&P 500 has been consolidating for two weeks now between 1100 and 1200 ever since the dramatic plunge earlier in the month. The question now is do we get a bear market rally that would logically retest the 1260 level on the S&P 500?

Just like the mess politicians are making with the debt ceiling debate, the stock market continues to trade in a choppy fashion for 2011. Currently we are in the third pullback in the giant trading range that’s been in effect all year.

If you simply looked at a chart of the Euro over the last year or so, and didn’t know about all of the problems facing the European Union, you could conclude that the Euro was just experiencing a pullback in an ongoing uptrend.

Gold stocks have had a nice bounce over the past couple weeks and gold investors are likely wondering if this long period of underperformance by the miners is finally drawing to an end. Even though gold is more than $150 higher than it was in November 2010, gold stocks are still at the same level as they were last November.

The oversold bounce continued to start the week with a strong move higher in the market today. Over the last 3 months the last 5 trading days of the month, often cited as window dressing time, have been strong.

The market bounced late in the session on Thursday on the heels of yet another band-aid attempt on the Greek debt crisis. This was also coupled with an attempt by the government to alleviate some pain at the gas pump by releasing oil from the strategic petroleum reserve.

Gold stocks continued to lose ground last week and have now hit the same level they were at in September 2010. Gold however was marginally higher last week and is still holding above its May 2011 lows. The divergence between gold and gold stocks is clearly visible on the next chart:

When investing in the gold sector one of the most frustrating experiences you can have is watching gold outperform the gold stocks in your portfolio. Investors flock to gold stocks to leverage the returns in gold, not underperform gold. The idea is that a rising gold price produces bigger profits for gold producers, and the market rewards increased profits with higher share prices. So when gold investors take on the elevated risk of buying gold stocks, they want to see their gold stocks outperform the price of gold when gold is rising.

May was the worst month for the S&P 500 since August 2010, but the percentage loss for the month only ended up being about 1.5%. The four day rally at the end of May, including the big up day on Tuesday, served to soften some of the damage done in May. But the market reversed all of that bounce in one day to start June with a massive selloff.

It’s usually constructive to go over the landscape of the market and get a feel for where things are at. Since the end of April we’ve seen the market undergo a definitive change of character. Instead of seeing most of the market in one big rally mode that we’ve become used to since September 2010, we’re seeing corrections, non-confirmations, and trend changes across different parts of the market.

Silver’s destiny with its 200-day moving average appears to be sealed this week as a brief bounce earlier in the week failed at the 50-day moving average. From peak to trough so far this correction has run about 35%, which is still less than the 37% correction silver underwent from its parabolic peak in 2006. And the rally in 2005-2006 for silver was dwarfed by this recent run. In 2005-2006 silver went from $6.64 to $15.21 for a 129% gain. The 2010-2011 rally took silver from $17.22 to $49.75 for a 189% gain. So if this recent silver parabola follows the “higher they rise, harder they fall” rule then we should see a bigger correction than 37% peak to trough.

Silver has sold off hard the first 3 days of this week and is down over 17% for the week. If silver falls more this week it will be the worst weekly loss for silver during this silver bull market. The next chart shows the weely and biweekly rate of change in the silver price and only a weekly correction in 2008 was worse than this correction so far.

The stock market had a very strong week last week with the major indexes all up close to 2% or more. The Transports were the big winner for the week up 4.24%. In the commodities complex gold actually outperformed silver last week, which hasn’t occurred since March. Money is likely flowing into gold instead of silver since gold is much less overbought than silver. Industrials, Health Care, and Utilities were among the best performing sectors for the week.

Silver attempted to take out 50 on Monday of this week and instead had a big reversal day as it temporarily ran out of gas. Then after testing 45 the following day silver has moved higher after the Bernanke press conference and is once again approaching 50. For the very short term silver appears to be trapped in the 45/50 box and is awaiting a break either above or below this box.

Silver continues its powerful and relentless move higher. From August 2010 until now this is the biggest rally during this silver bull market that started early last decade. Silver has also been the star performer of the financial world over the past year.

The slogan "the trend is your friend" was created for a reason. People tend to agree more often than disagree with their friends. Aligning yourself with the long term trend means you are choosing to agree with the wisdom of the market. Good friends typically help each other out too, and when you trade with the trend you let the market help you choose the correct direction to align your long term investments with.