Pet Cemetery

OK this title may be a stretch but stay with me because while the title is not significant there is an important set of lessons to learn.

I was a big Steven King fan in my younger years and read every book he wrote. Without retelling the entire story and giving it away, Pet Cemetery was the story about a family who buried “things”, initially starting with a pet that had died, in their backyard. The twist was those “things” that got buried eventually came back to life. As you will see below, the aforementioned “dead horse” of last week’s post, GDXJ, must have been buried in the main characters of Pet Cemetery’s backyard as has risen back to life.

Most times I don’t cover potential outcomes that would be different than the point of my post. This is partially because I try to keep my posts short and succinct but also because I can’t, due to SEC regulations, provide investment advice to the “general” public. So the more information I provide the more it could be deemed advice or a recommendation. So I walk this fine line always wanting to insure regulatory compliance. These post are just to provide ideas as I expect anyone reading will be doing their own due diligence and to determine if it works for them. What I left out of last week’s post was the possibility of what is known as a bear trap, or in other words a case where my horse wasn’t really dead, just severely wounded. Let’s take a look at the chart I posted last week which showed GDXJ breaking down below the $18.2 major support level and see if I can show you the bear trap. These are not rare, one-off occurrences as such are important to recognize and understand because they happen often enough, especially in small, thinly traded markets.

A bear trap is where the market makers sell some of their inventory to push price below a level of very visible major support. This has the following effect; those that were long the security see this support level being broken and sell their shares to cut their losses. This selling helps to drive prices lower. Those that were bearish but waiting for a break below support, pile on short adding to the downward pressure. Once this plays out then comes the short squeeze or bear trap. Usually within a day or two of the support break, those same market makers who sold some shares to start the cascade lower, begin buying back shares trying to push price higher. The try to buy only enough to move price back above the prior support (which has now become resistance) level. Once that happens, those that had piled in short are forced to close out their short positions, adding fuel to the buying frenzy driving prices higher. Those, sneaky market makers make money by playing the investors emotions knowing how most will act because the fear of losing is a very powerful motivator. This is exactly what occurred with the miners as you can see in the updated GDXJ chart below.

There is a saying that from false breaks come big moves. This was a great example of a false break so we have to be open to the fact this move higher could be substantial. For now, I do not waiver from my bearish long term view that we will eventually see lower prices. For now, we will rally from an oversold condition allowing the market makers another chance to unload some shares at higher prices before it falls again. Until proven otherwise this is just a short squeeze, counter-trend bounce in a bear market.

So what’s the “take-away” from this example?

· There is always the chance you will be wrong so it’s an absolute requirement to have your course of action mapped out BEFORE you enter into an investment, in case it goes against you. There is no one action plan that works for everyone so yours should be based upon your investment style, risk tolerance and time period used.

· Being wrong is OK as it is a part of investing and a potential outcome any time you put capital to work in any market. Staying wrong is not.

· Cut your losers quick and let your winners run. Over the long haul this is how you insure long term out-performance, lower risk and preserve investment capital.

· Waiting for confirmation (2nd and 3rd day follow through to the downside for example) can greatly improve success rate but will lessen any gains.

·  Steven King and investing may not be a great combo, not unlike a strawberry Popsicle with ranch dressing.

Don’t Leave Home Without It

Almost 6 months ago to the day I wrote about the US broad market struggling going sideways but when looking under the hood a lot of stocks forming major topping patterns. I provided a couple of examples, one being American Express, AXP. Of the two, it was the one I felt least comfortable throwing out there because of the magnitude of the loss the pattern was projecting. As you can see in my original chart below, the first target (labeled as T1) was some ~25% below and the second (T2) was ~35%. Without the markets crashing and burning there was no way I felt either of those targets were realistic. I went ahead with the post anyway because all I am is the messenger.

Fast forward to today and even though the markets have not yet crashed and burned (a couple of manageable 10-11% corrections … so far) American Express has not only met my first target (T1) but is well on its way to the second (T2). And looking at the magnitude and voracity of the decline it looks like T2 may not be the end of its fall and a retest of the 40 level looks very possible. That would be a 50% haircut from the date of my original warning post if that were to occur. 

Congratulations for those who followed along.  You are up a cool 30% in six months. Not a bad annualized return. The further it falls, the greater the risk of a reversal so while I am not making a recommendation, I would ensure I had my exit plan mapped out.  One element of it should be to consider booking some or all profits at T2 and let the balance, if any, ride with a tight stop seeing if 40 is in the cards.

Beating a Dead Horse

I do keep a regular pulse on the precious metals market and I continue to be amazed at the resiliency of the (remaining) gold bugs in spite of the drubbing they have taken since the 2011 highs. We have seen repeated bottoming attempts only to have the rug pulled out and prices fall further throughout this entire 5 year decline.

Fast forward to July of last year. You can see in the chart below of the small cap miner ETF, GDXJ, price first found a bottom in the $18.20 area, chopped around and created a higher high in October giving the bulls some hope. Notice also, how that same $18.20 provided support during the entire 6 months + consolidation as it retested it many times. Sadly, the bulls hope was squashed in December as the next impulse move higher was lower than the previous, wiping out the hope for a new uptrend. The final nail was put into the coffin on Friday as the $18.20 failed support and prices are following strongly through to the downside today.

Unless there is some catalyst and we reverse back up here in the next few days, I see another plunge in the works. The head and shoulders pattern that was formed projects to a target around 15, some 17%+ lower than where we were on Friday. I don’t know if that will be it, but because of the carnage that has already taken place, I will be looking for the next flush down to be its final and the potential beginning of a reversal. But for now, the charts are telling us the bears are in charge and making money will not be done buying or holding.

What is Up With the Yen?

I got a call from a friend last week. She asked me about the yen and what I thought. I don’t look at currencies too often as they are pretty illiquid and minimally available in the securities market where client brokerage accounts are held. Additionally, no one will become rich investing in currencies in brokerage accounts so I tend to focus investment attention on stocks, bonds, some commodities and hard assets. Trading currencies is best done via FOREX markets because of the leverage they bring.

Being the natural skeptic I am, my immediate thought when she mentioned it was the yen, really? The dollar is so strong (right now) and the yen so weak there is no way! I pulled up a chart and was pleasantly shocked at what I saw because she was right. As you see in the chart below the yen has been basing for more than a year and has formed an inverse head and shoulders reversal pattern. Last week’s close was just above the neckline and what I would consider as a decent entry point upon confirmation. Add to that it has created higher highs and higher lows while price has risen above a flattened 200 day moving average which looks like it is now starting to curl up. These are all positive and things I need to see before I consider investing in something that has been in as severe a decline as the yen has. I do have my biases and would consider this a “trade” and not investment. I say this because fundamentally I don’t see a rising yen lasting as the Japanese government and central bank are doing everything possible to weaken it and until that changes I think it is doomed long term. For clarity, the difference between a trade and an investment is the time frame. A trade will be shorter in time, likely be a year or less probably months (they have even been as short as a few weeks) and an investment, longer. I prefer to avoid “trades” and hold out for “investments” in client accounts whenever possible.

As you know I try to not spend a whole lot of time on why an investment is doing what it is doing but in this case I am going to as there is a valuable lesson to learn and keep in mind. With the fundamental backdrop being so negative for the yen one has to wonder why it would be moving in the opposite direction it should be. Historically the yen is considered a safe haven (much like the dollar) during times of (stock) market stress and it appears that Mrs. Market is once again remembering that correlation

Because the yen and stocks move in opposite directions, I would expect this yen rally to have some legs as I don’t think we are anywhere close to being done with the stock market decline. But once we are, I think this trade will likely have run its course.

Ay Carrumba

In June of last year I wrote about the double top in Mexico’s stock market ETF, EWW and the (blue) bear flag that was forming which I posted in the chart below. You can see at the time, I labeled the breakdown target from the flag with a black horizontal line which came in around the prior 2011 lows at ~$45. This projected to a 20-25% loss depending upon where you measured the starting point from (the top or bottom of the flag)

Fast forward to today with an updated chart below. You can see we hit the target not once but twice and sit just above the line.  This confirms how important this price as support as it has now bounced off 4 times over the past 4 years.

For those that followed along, congrats but it’s time to lock in the 20+% profit and move on. But is it? You see, when prices are strongly trending (in either direction) many times once one pattern has completed another one forms and EWW is no different. In this case we have now formed a very large, bearish complex head and shoulders topping (in red) pattern which brings with it a much larger potential for profit if it breaks down and you are short. A break and confirmed move below the neckline could be the beginning of the start of its next leg down. While it is hard to write this because it seem so implausible,  the pattern target projects down at around $20, some 43% lower than where we sit today and back right at the 2009 lows. If this works out all I can say is Ay Carrumba!