Friday, July 12, 2013

Dow Theory Update for July 12: Dissecting GDX and SIL’s secondary reaction

I am writing before the close, so I cannot provide you with closing figures. If the Transports exceed their 05/17/2013 closing high, then a primary bull market would be signaled, as both the SPY and the Industrials broke up their respective closing highs yesterday. More about such breakup, and the relevant chart here.

If GLD and SLV closed up today, the secondary trend would change to bullish. Let's see what happens.

Yesterday, I warned my readers that a secondary reaction had been signaled for GDX and SIL according to the Dow Theory. Let’s dig a little bit deeper.

As you can see on the chart, GDX and SIL have been rallying for the last 10 trading days. Thus, the time requirement of a minimum of 10 trading or even calendar days has been met.

When dealing with stock indices, for a rally to be meaningful, the Dow Theory demands a minimum of a 3% in at least two indices. However, since we are dealing with GDX and SIL (quite a different beast), we have to adjust the minimum rally threshold to reflect the greater daily volatility of the gold and silver miners ETFs. If we’d satisfy ourselves with a mere 3% rally, we would get lot’s of false signals given GDX and SIL larger volatility. It’d be like just demanding a 1% for the SPY or the Industrials. Noise would overwhelm signal.

So let’s measure first the percentage gained in this rally by GDX and SIL.


Pctg made

GDX has rallied 16.24% off the 06/26 lows, and SIL managed to bounce 12.42%.

Let’s see whether such move is significant. To this end, we calculate the ratio of SPY’s volatility (30 days standard deviation of close) with GDX’s and SIL’s volatility.

volt adjust

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Min Rally


Thus, we can see that GDX’s volatility is 2.58 times larger than SPY’s, and SIL’s volatility is 3.05 times larger than SPY’s. If we apply this multiplier to the 3% minimum move for stock indices, we obtain a minimum rally of 7.75% for GDX, and 9.17% for SIL.

Accordingly, GDX and SIL rally of 16.24% and 12.42% do qualify as a meaningful rally according to the Dow Theory.

Given that both the time (10 trading days) and extent (more than 7.75% for GDX, and 9.17% for SIL) requirements have been met, we label rally that originated on 06/26/2013 as a secondary reaction against the primary bearish trend.

Here you have a chart that says it all:

Blue rectangles show ongoing secondary reaction in SIL and GDX
If at least one ETF undergoes a pullback exceeding 7.75% for GDX, and 9.17% for SIL (the volatility adjusted equivalent of 3% for the SPY), and after such a pullback both ETFs break above the secondary reaction highs (upper boundary of the rectangle), a primary bull market would be signaled. However, don’t forget, as it happened in the past, that if the rally fizzles, and both ETFs violate the last recorded primary bear market lows (06/26/2013), the secondary reaction would be declared dead, and the primary bear market would be reconfirmed for the nth time. So, once again, I will exert lots of patience, as good old Charles Dow counseled to investors.

If both ETFs refused to undergo a pullback, and would shoot up and break above the last recorded secondary reaction highs (horizontal blue lines on the charts), a primary bull market would be signaled. While this primary bull market signal, without an intervening pullback, is kind of infrequent (less than 10% of occurrences), it is not to be neglected.


The Dow Theorist


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