Monday, October 5, 2020

Dow Theory Update for October 5: Dissecting the current secondary reaction in gold and silver


Explanation for SIL and GDX coming soon


As I wrote here, the secondary trend for precious metals had changed on September 23rd, 2020. I promised a more in-depth post.


Today, I’ll address gold and silver. Hopefully, next week, I’ll write about SIL and GDX, the gold and silver miners ETFs. 

Please mind that I am writing before the close of October 5th, 2020. So things might change after the close. Readers beware.



Introductory note: In this post, I wrote a thorough explanation concerning the rationale behind my use of two alternative definitions in order to appraise secondary reactions.


A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks and/or 1/3 retracement dogma.

The primary was signaled as bullish on 02/19/2020, as explained here.


The secondary trend was signaled as bearish (secondary reaction against the primary bull market) on 09/23/2020, as explained here.


SLV declined for 31 days and GLD for 33. So the time requirement was more than met.


As to the extent requirement, I performed the following calculations:



SLV dropped -21.59% and GLD -9.88%. When applying the Dow Theory to US stock indices, we require a minimum movement of 3% for a movement to be taken into account. Swings not reaching 3% are to be discarded (negligible movement). When we venture outside of the realm of US stock indices, I feel we should consider the different volatility of the financial assets concerned. This is why I perform a volatility adjustment. I compare the daily percentage change of the asset in question to that of the SPY. If, for example, SLV had a double daily average percentage change than the SPY, then the minimum volatility requirement for SLV would be 2 x 3% = 6%.


Since volatility changes, I performed 200 days and 1000 days average calculations. As you can see in the spreadsheet above, the pullback underwent by both SLV and GLD clearly exceeds the minimum volatility-adjusted movement (around 4.25% for SLV and 2.36% for GLD). Being influenced by Schannep’s Dow Theory which does not use retracements but absolute percentage swings, I’d say that given the magnitude of the pullback, I’ll consider the extent requirement fulfilled.


The icing on the cake which confirms beyond any shade of doubt that there is a secondary reaction is the existence of a confirmed retracement of the previous bull market swing (from the lows of the last secondary reaction to the highs of 10/8 and 6/8) exceeding 1/3 on both ETF (36.92% for SLV and 34.31% for GLD).


By the way, based strictly on the Dow Theory, I alerted about the enhanced likelihood of a secondary reaction by the end of July 2020. Several warning signs piled up: Excessive volume and, more importantly, several divergences. You may read the full explanation here.


From the September 23rd, 2020 closing lows, SLV rallied 4.53% until 9/29/2020. GLD rallied 2.23% until 10/01/2020 (unconfirmed by GLD). As you can see in the spreadsheet above, we are barely reaching the minimum-adjusted movement to setup SLV and GLD for a primary bear signal. So I’d like to see some more market action in order to unambiguously state that the setup for a primary bear market has been completed. We are in a borderline situation. However, if GLD and SLV suddenly broke down below their 09/23/2020 secondary reaction lows, and such a decline were with heavy volume, I think I’d act and declare a primary bear market signal because of the following reasons:


1. Under this section, we deal with a somewhat shorter-term Dow Theory interpretation. So, as a matter of principle, we shouldn’t overstay trades.


2. At the close of 10/2/2020, we have some decent unrealized profits, which could go away if we are not quick to react in case the 09/23 lows are jointly broken down:

3. The secondary reaction is an undeniable one: 31 and 33 days of declining prices. Given all the divergences that preceded it, I’d be inclined to take the money and run. We can always re-buy, once SLV and GLD jointly better their 08/06 and 08/10 closing highs. Some readers might say: “But if you sold at the breaking down of the September 23rd lows only to re-Buy at the breakup of the August 8th and 10th highs, then you would have made a bad trade”. That much would be true but, we never know how far SLV and GLD can drop if the September 23rd secondary reaction lows are jointly broken down. Rhea used to say that the points lost by re-buying at a higher level are merely the “cost of insurance” in case a real bear market sets in at the breaking down of the secondary reaction lows. In some instances, we will regret our having had to re-buy at a higher price. Nonetheless, when the sudden sizeable decline hits, we will recoup the cost paid by our insurance.


Here you have a chart displaying the price action spanning from the last secondary reaction lows (orange rectangles on the left side of the charts) till October 2nd, 2020.


 B)  Market situation if one sticks to the traditional interpretation demanding more than three weeks of movement in order to declare a secondary reaction.


The primary was signaled as bullish on 02/19/2020, as explained here.

On September 23rd, 2020, the secondary trend turned unambiguously bearish (secondary) reaction. SLV declined for 31 days and GLD for 33. So the time requirement, even when one takes the longer view, has been amply met.


As to the extent requirement, it has also been amply met. Both in terms of absolute volatility-adjusted decline and retracement (36.92% for SLV and 33.71% for GLD).


The spreadsheet below tells all the story:



Please mind that since the primary bull market signal of 2/19/2020, no secondary reaction had been signaled until now. By strictly requiring at more than 3 weeks of declining prices, the pullback of March 2020 (17 days for SLV and 8 days for GLD) did not qualify as a secondary reaction. 


Here you have an updated chart. The grey rectangles display the big pullback of March 2020 which, nonetheless, did not qualify as a secondary reaction. The orange rectangles show the current secondary reaction against the primary bull market.


All the explanations given in the preceding section do fully apply here. Hence, we keep a watchful eye to the September 23rd, 2020 secondary reaction closing lows.



One Dow Theorist

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