Stalking the Gold ETF for Re-Entry

02/26/2009 12:01 am EST

Focus: ETFS

Deron Wagner

Founder and Head Portfolio Manager, Morpheus Trading Group

Stocks snapped their vicious, six-day losing streak Tuesday, as the major indices roared back from Monday's steep losses. The broad market opened modestly higher, chopped around in a sideways range throughout the morning session, then zoomed higher in the afternoon. The Dow Jones Industrial Average gained 3.3%, the Nasdaq Composite 3.9%, and the S&P 500 gained 4.0%. Both the small-cap Russell 2000 and S&P Midcap 400 jumped 4.5%. Opposite of the previous day, all the major indices closed near their intraday highs.

Tuesday's rally was as powerful as the weakness of the prior session's sell-off, perhaps even more so. Not only did the major indices erase the previous day's losses, but they did so on higher turnover as well. Total volume in the NYSE increased 14%, while volume in the Nasdaq rose 16% above the previous day's level. The broad-based gains on higher volume enabled both the S&P 500 and Nasdaq Composite to score a bullish "accumulation day," indicative of buying amongst mutual funds, hedge funds, and other institutions. We'll be closely monitoring for additional "accumulation" in the coming days because the presence of substantial institutional buying is necessary in order for the stock market to form at least an intermediate-term bottom.

In the February 18 issue of The Wagner Daily, we explained the reason for locking in a 36% gain in our Gold Double Long (DGP) position the previous day. Specifically, we said, "Although we remain bullish on the long-term trends of the gold and silver ETFs, they may be setting up for at least a short-term pullback. This assessment is based on the fact that spot gold is approaching significant resistance from its July 2008 high, and has also moved more than 10% above its 50-day moving average. A historical, multi-year look at the chart of the shiny commodity shows it has a consistent tendency to correct every time it moves more than 10% above its 50-day moving average." Further, we said: "Gold will certainly remain on our radar screen for potential re-entry, but we simply opted to lock in a handsome gain, rather than sitting through a possible correction." Thereafter, the gold and silver ETFs attempted to move slightly higher, but as anticipated, they began to enter correction mode yesterday.

In yesterday's session, SPDR Gold Trust (GLD), a popular ETF proxy for the spot gold commodity, fell 3.1%, while iShares Silver Trust (SLV) lost 5.1%. Much worse was the 8.1% decline of Market Vectors Gold Miners (GDX), which is comprised of a basket of individual gold mining stocks. Based on this short-term correction that has begun in precious metals, it seems the pattern of spot gold pulling back substantially after rising more than 10% above its 50-day moving average remains intact. Nevertheless, the long-term trends of gold and silver look pretty bullish. As such, we'll be monitoring for a potential re-entry in the gold/silver ETFs. Check out the annotated daily charts of these three ETFs below:

Comparing the charts above, notice that both GLD and SLV closed right at short-term support of their ten-day moving average (the dashed purple line). GDX, however, is now showing significant relative weakness to GLD. Notice that GDX sliced through its ten-day MA, 20-day EMA (the beige line), and its 200-day MA (the orange line). Because of the clear bearish divergence GDX is exhibiting, we'll now look for buy setups on spot gold (GLD, DGP) and spot silver (SLV) instead.

In the near-term, gold and silver will likely follow one of two paths. |pagebreak|

The first possibility is a steeper pullback to their 20-day EMAs. This moving average has acted as support for GLD several times since mid-January, but SLV has been so strong that it has not even touched its 20-day EMA since then. The second possibility is that GLD and SLV will now form "bull flag" chart patterns, essentially correcting by time, rather than price. Either way, we'll be closely monitoring behind the scenes for the next ideal buy entry in these ETFs, and will promptly inform subscribers when we spot those buying opportunities.

Two days ago, we pointed out a potential short-term buy setup that was forming in CurrencyShares Euro Trust (FXE). At the time, we were looking to play a momentum-based, countertrend bounce off a major area of price support. But to prevent premature entry, we were looking for confirmation of a rally above the 20-day EMA and month-long downtrend line. That breakout has not yet happened, but looks as though it could trigger very soon. Take an updated look at the daily chart of FXE:

When the Dow broke below its November 2008 low last week, we cautioned against placing too much emphasis on that bearish signal because both the S&P 500 and Nasdaq Composite were still above their November lows. Further, we said the Dow was a very narrowly based index of just 30 blue-chip stocks—not really indicative of the overall health of the broad market. Notably, yesterday's rally occurred precisely as the S&P 500 tested critical support of its November 2008 low. If Tuesday's rally holds over the coming days, it sets up the broad market for the possibility of intermediate-term strength, based on the double bottom formation of the S&P 500.

Obviously, a strong, one-day rally does not give us the "all clear" signal to start aggressive buying operations. In fact, there are very few ETFs with buyable chart patterns right now. Nevertheless, the rally off the S&P 500's November low was convincing enough to avoid the short side of the market for now. We'll be closely watching the market for new ETF setups that develop in the coming weeks, but we like the idea of a mostly cash position (except GLD, SLV, and FXE) until the market decides whether or not Tuesday's rally was legitimate and sustainable.

By Deron Wagner of Morpheus Trading Group

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