Thursday, August 15, 2013

Dow Theory Update for August 15: Explaining the latest primary bull market signal for SIL and GDX



 Stocks collapse on heavy volume


Dow Theory relevant events are piling up, and my time is in short supply. Let’s try to address them in today’s post on this blog.

Fofoa’s best explanation of negative GOFO and what it means for physical gold.

Yesterday, I alluded to an interesting article on Seeking Alpha concerning GOFO, vanishing inventories and its bullishness for gold. I closed my observations by saying that I’d stick to physical gold, and disregard any other surrogate.

Well, it seems that FOFOA has made clear for all to see that the only sensible long term investment in gold is the “real thing”. In my post “Not all “gold” is born equal. Gold and the Dow Theory, I made clear in unambiguous terms that when it comes to a fundamental view on gold (yes, even me, the pure technical Dow Theorist, has a fundamental opinion on things), I subscribe 100% to the views expounded by FOFOA.

Today FOFOA has penned the definitive article whereby he explains what a negative GOFO really means, and the implications for the physical gold market. FOFOA makes clear that only physical gold will do the trick. We should forget (unless we are short term trading) other “securitized” substitutes. All readers of this blog are kindly encouraged to read FOFOA’s “My Candid View –Part 2”, which you can find here.


All in all, in my opinion FOFOA is second to none when it comes to a fundamental analysis of the gold markets. Period. 


More on SIL and GDX primary bull market signal.

Yesterday I reported that a primary bull market was signaled by the Dow Theory for SIL and GDX, the gold and silver miners ETFs. Well, let’s carry out our analysis further.

The primary bear market for SIL and GDX was signaled under the Dow Theory on 01/23/2013. On that date SIL closed at 21.70, and GDX closed at 44.56.

The primary bear market lows were made on 06/26/2013, when SIL closed at 10.59 and GDX closed at 22.22.

Thus, SIL lost -51.19% and GDX lost -50.13%.

Well, this is a monster bear market, if we are to compare SIL and GDX with our Dow Theory record for stock indices. A primary bear market that wipes out more than 50% is a rare occurrence.

As far as time is concerned, this has been an average primary bear market. Since the primary bear market signal was signaled on 01/23/2013, more than six months elapsed. This is the average duration of a primary bear markets when dealing with stock indices.

Thus, we have witnessed a monster bear market in extent (loss), whereas its duration was average.

While I don’t want to brag, as lack of humility is lethal when it comes to investing, it is clear that the primary bear market I spotted on January 23 did a pretty good job at keeping investors safe by avoiding a loss exceeding -50%. Remember that in many posts (example here) I was tempted by bullish fundamental calls (and experts calling bottoms which were proven repeatedly wrong) made by the likes of Sinclair. I am not demeaning Sinclair and others of his ilk, since I acknowledge their brilliancy. However, when it comes to putting money on the line, or at the very least, timing a fundamental view,  I rather prefer to trust the time-tested Dow Theory rules. Timing is everything. You can go bankrupt being fundamentally right due to poor timing.
 
Of course, I could have been wrong when I declared a primary bear market on January 23. SIL and GDX could have rallied no sooner I had declared the primary trend as bearish. It could have been a failed bear signal. Furthermore, if I judge according to the Dow Theory record, 40% of primary bear market calls fail, which means that money would have been made by disregarding the bear market call (which forces us to go to cash). However, we don’t need to be right on each market call. What we need to achieve is to eschew the monster bear market, something which we have avoided. I rather prefer to have 40% of failed bear market calls, with an opportunity cost for each of, say, 5%, than being all the time fully invested and suddenly see 50% of my investing equity being ravaged by a vicious bear market.

Thus, I am not bragging about the accuracy of the Dow Theory. I could have been wrong. However, I am convinced that the beauty of the Dow Theory lies not so much in outperforming “buy and hold” or in being always right, but in protecting the investor’s equity when things really get tough. My Dow Theory studies have proven beyond a shade of doubt that the Dow Theory swiftly signals changes of trends thereby protecting the investor.

Now we don’t know how long or how much money we can make or lose by buying SIL and GDX. The duration and extent of primary bull markets are not known in advance, even though we know that the average bull market for stock indices lasts 1-2 years on average. Please mind the word “average”.

We know, though, one important thing about this primary bull market signal. Our Dow Theory stoploss lies at the primary bear market lows of 06/23/2013, and, as you can read in the spreadsheet below our Dow Theory stoploss is a very ample one: -45% for SIL and -29.16 for GDX.

Thus, this particular primary bull market signal and its concomitant setup (primary bear market lows, secondary reaction, pullback, breakup) is not the best one in terms of reward risk ratio. We don’t know how much we stand to make, but we know how much we stand to lose if the market suddenly reverses without any intervening secondary reaction. Such initial ample stops of -45% for SIL and -29.16 for GDX warrant caution, which means that I would never make a commitment that could entail such a big loss. Personally, I’d never allow a loss greater than 10% of my total trading/investing equity. While this is very personal, this necessarily implies a commitment of modest proportions for GDX, and an even smaller one for SIL. Thus, if I had USD 100,000 cash to invest right now, I would merely invest roughly 34,000 in, i.e., GDX which implies a potential loss of ca. USD 10,000 if our Dow Theory stoploss is hit. For those favoring SIL, I would even make a smaller commitment of roughly 22,000. Of course, position sizing is an art and depends very much on the risk tolerance and the investor psychological make up. I am just giving my readers food for thought.

We have talked about the risk, and more importantly, how to limit it so that it doesn’t exceed, i.e. 10%. What about the reward? Well, we know that primary bull market signals, when profitable deliver ca. 40% gains on average. Since we are dealing with SIL and GDX which have a much greater volatility, it is not outlandish to suggest a profit of 80%, if things go well. Thus, we are talking of a reward risk ratio near 2 for SIL, and 2.66 for GDX. While not the best reward risk ratio, it is decent enough (especially for GDX, even though until now it has been the weakest peer).

Stocks

The SPY, Transports, and Industrials closed down.

The primary trend is bullish, as explained here, and more in-depth here.

As to the secondary trend, I withhold judgment today. Tomorrow, I will explain why I feel it hast turned today bearish.

Today’s volume was higher than yesterday’s. Since stocks closed down, expanding volume has a bearish connotation. For the reasons I gave here, I’d say that volume is bullish in spite of today’s rout. Until yesterday, we had six consecutive bullish volume days, and the last breakup of 08/01 was a bullish pivot, as was explained here.

Gold and Silver

SLV and GLD closed strongly up. GLD confirmed SLV’s breakup, and both are well above their 07/23 closing highs. Such breakup could even be qualified as a primary bull market signal, but I have my reservations about it. I hope to find time tomorrow to explain it, but I feel the pullback that followed the 07/23 secondary reaction highs didn’t have enough magnitude to be a “qualified pullback” for a primary bull market signal setup under the Dow Theory. Of course, any breakup is bullish under the Dow Theory, and what gold did today is bullish. Period. However, things get tricky when we try to classify the kind of “bullishness." Does it merely confirm the secondary bullish trend? Or it is a harbinger of something bigger (i.e. a primary bull market signal). Tomorrow I hope to shed more like on this tricky technical situation. I don’t want to make a rash judgment because the implications of a primary bull market for (paper) gold would be far-reaching. More about such implications tomorrow.

Until I change my mind, the primary trend is bearish, as explained here and reconfirmed bearish here. The secondary trend is bullish (secondary reaction against the primary bearish trend), as explained here.

Here you have a chart depicting the latest price action of SIL and GLD.

Silver and gold are getting bullish. But bullish enough for a primary trend to be signaled?
 
GDX and SIL closed up, and, unlike GLD and SLV, are unambiguously in a primary bull market under the Dow Theory, as explained here. The secondary trend is bullish as well.

Next weekend I will post a new episode of my saga "Face off: Schannep versus "classical" Dow Theory". Readers of this blog stay tuned, as I will deliver groundbreaking information.



Here you have the figures for the SPY, GDX and SIL which represents the only markets with suggested open long positions.


DOW THEORY PRIMARY TREND MONITOR SPY




SPY
Bull market started
06/24/2013 157.06
Bull market signaled
07/18/2013 168.87
Last close
08/15/2013 166.38
Current stop level: Bear mkt low

157.06




Unrlzd gain % Tot advance since start bull mkt Max Pot Loss %




-1.47% 5.93% 7.52%

 

DOW THEORY PRIMARY TREND MONITOR ETF SIL




SIL
Bull market started
06/26/2013 10.59
Bull market signaled
08/14/2013 15.36
Last close
08/14/2013 15.91
Current stop level: Primary bear mkt low 06/26/2013 10.59




Unrlzd gain % Tot advance since start bull mkt Max Pot Loss %




3.58% 50.24% 45.04%




DOW THEORY PRIMARY TREND MONITOR ETF GDX



GDX
Bull market started
06/26/2013 22.22
Bull market signaled
08/14/2013 28.7
Last close
08/14/2013 30.43
Current stop level: Primary bear mkt low 06/26/2013 22.22




Unrlzd gain % Tot advance since start bull mkt Max Pot Loss %




6.03% 36.95% 29.16%



Sincerely,

The Dow Theorist

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