Dow Theory special issue: Gold and silver miners ETF secondary reaction

 Are we sure?

In my Dow Theory Update of October 23, I announced that the Dow Theory had signaled a secondary reaction in the gold and silver miners ETFs.

Here you have a chart showing recent price action (until Oct 23)

Caught within a line

The red line is the SIL/GDX ratio which, as you can see, remains bullish for silver.

The last joint highs were made on 09/21/2012. SIL closed at 25.26 and GDX closed at 54.81.

The last minors lows were jointly made on 10/15/2012. Such lows have been violated today. SIL closed at 24.13 and GDX closed at 50.96.

Hence SIL has experienced a 4.44% down move and gold has gone down by 7.02 %

And here comes when Dow Theory gets subjective. I’ve always written that the Dow Theory is not math.

While at first sight 4.44% and 7.02% down movement fully qualifies as a secondary reaction, since the movement exceeds 3%, I have my qualms after adjusting for volatility.

I conducted the following volatility adjustment. Look at the table below:

	Daily volt %	Ratio	Min      Movement	Line
SPY	0.58
SIL	1.58	2.724	8.172	13.620
GDX	1.4	2.413	7.241	12.068

The column “Daily Volt %” shows the daily volatility in percentage points (average of the last 30 days).

The column “Ratio” is the ratio of GDX and SLV volatility to SPY’s volatility. Thus, we can see that SIL daily volatility is 2.72 higher than that of the SPY.

The column “Min Movement” reflects the minimum 3% movement we demand for stocks (SPY) times the “Ratio”. It is the adjustment of volatility to compare apples to apples.

And here comes my little surprise. SIL should have experienced a minimum down movement of 8.17% and GDX 7.24%

So if I am strict, and I demand a volatility equivalent to that required for stocks, I must conclude that we are not in a secondary reaction yet. GDX has almost reached the minimum required movement. SIL is far from being 8.17% down.

While these figures are not carved in stone, and we could be somewhat flexible with GDX, I feel that silver is far from being near 8%.

On the other hand, I almost see a secondary reaction from an alternative source: The “line” (trading range).

The blue rectangles show the “lines” being formed in both the GDX and SIL. When dealing with stocks a “line” is formed when during 2 to 3 weeks or longer prices are within a range of ca. 5 per cent or less.

With GDX and SIL, and after adjusting for volatility, we could talk of a line when prices are within a range of ca. 12% or less. The column in the table above "line" shows the volatility adjustment for GDX and SIL.

So it seems that GDX and SIL are within a line.

I also see that on Oct 23, GDX violated the lower boundary of the line. SIL, however, refused to do so.

So we have a very mixed situation: We almost have a secondary reaction if we judge by the decline from the highest highs. We almost have a secondary reaction if we judge by the breaking of the line. However, such violation of the lower boundary by GDX has not been confirmed by SLV.

A third criterion to determine the existence of a secondary reaction is the percentage retracement of the previous up move. I have made some BOE calculations, and SIL has merely retraced 14% whereas GDX has retraced 24.4%. While the 1/3 to 2/3 requirement is not carved in stone, and even Rhea broke these rules on many occasions, I feel that a mere 14% and 24.4% for both ETFs is a too meager retracement.

Given the action of gold and silver I feel tempted to say that SLV and GDX are in a secondary reaction too. However, to be strict, I need to see a little more price action. If silver breaks below its lower boundary, then there will be no doubt that both ETFs are under a secondary reaction.

There is nothing wrong with being cautious. Again, I insist that we are not in the business of trading secondary reactions but to avail ourselves of them to our benefit. 

Furthermore, I want to be honest and not to be proudly sure when the market refuses to be as clear as I wish it to be.  The good think is that primary trends are easier to determine than secondary reactions which as you begin to see are really elusive in real time. What is really important is to be able to think and apply all the Dow Theory tools at our disposal.

Sincerely,

The Dow Theorist