Very interesting article from David Nassar regarding current market conditions:
Investing in an event-driven market
Commentary: Gold may be ready to break through
By David Nassar
Last Update: 12:01 AM ET Sept. 23, 2005
BOULDER Colo. (MarketWatch) -- In my Sept. 14 column, I suggested the S&P 500 was likely to pull back to the 1,225 level and that might be a good place to buy.
This level proved important, given the market did pull back to 1,226 and then followed through with a rally to 1,237 -- but as we know this rally has succumbed to the events now upon us.
Therefore, we must reconsider the rally broken, given the broad market is now below 1,225. My hope is that readers acted on this level and were stopped out. As such, much fear is now in the market, and we must consider the next possible levels of support.
These appear to be as low as 1,200 and 1,191 given the momentum of the decline, market breadth and internals (advance/decline). This changes our focus from the broad market to what is now a "market of stocks."
Most often we have a stock market, and other times a market of stocks, and this week's severely negative price action points us in the direction of being highly selective of sectors and stocks.
This leaves some housekeeping on prior columns in which I strongly suggested the broker dealers (XBD: news, chart, profile) , which I have been recommending for several weeks.
Given the extreme fear component now in the market, I suggest setting stops on this group at 172.80. If penetrated, exit immediately and take profits. Both E-Trade Financial (ET: news, chart, profile) and Ameritrade Holding Corp. (AMTD: news, chart, profile) were noted in particular, which rallied nicely, but these positions must now be considered guilty until proven innocent, given the current market condition.
Once we gain support within the broad market, I believe this group will be quick to react and trade with relative strength, but until then -- take profits and wait for a lower entry opportunity.
Now, moving forward, other groups to consider include the gold and silver sector, which still have much more room to move higher. From a comparison basis, this group still trades low relative to energy -- a well respected ratio worth considering.
Let me explain.
Prior to the rate hike on Tuesday, the S&P's were trading higher ahead of the news, until Greenspan confirmed the inevitable. This drove the dollar higher while gold suffered, as did crude.
The rate hike news was just fine and the market liked Greenspan's words as a whole -- until the fears in the gulf re-emerged like a bad dream. As this fear exposed itself (See the VIX , representing the most volatile action in years -- up more than 9% in just one day), gold made a 17 year high -- signaling a breakout opportunity (which can also be well tracked by the XAU -- suggesting a breakout above 111.49 is due anytime). Upon viewing the XAU chart, this technical picture will be clear.
Fundamentally, there is a well-respected ratio between gold and energy that also can not be ignored, and currently we see that it takes seven barrels of oil to buy one ounce of gold. This 7:1 ration is considered to be quite low. If the dollar weakens further over the coming months -- as many currency analysts believe, gold will have both fundamental and technical support to go higher -- expanding this ratio. This could be a source of opportunity to buy low volume pullbacks in gold.
Currently we have gold trading at approximately $475/once (divide by seven for the approximate price of crude), and if the dollar does in fact find resistance, we will see a higher gold price which in turn will increase the gold/crude ratio.
You may think the gold/crude metrics are completely independent of each other, but in fact they are historically accurate gauges of economic stability and have great influence on the monetary policy.
That stated, this puts pressure on the Fed to create a soft landing for short-term rates, and many believe the one vote of the 9:1 decision to raise on Tuesday was more telling of the fed's future plan than the nine votes to raise or wording that followed.
Traditionally speaking, a weaker dollar increases the price of gold. Conversely, rising interest rates supports the dollar (making it more attractive to hold) and weakens gold, and it is this fundamental principal that one must consider -- regardless of the recent divergence whereby both the dollar and gold have shown strength.
The fact is, gold has been far more resilient than the dollar and the dollar has received great help from the Fed (higher interest rates improve the attractiveness of the dollar). And while this year has been good for the dollar, the dollar has been consolidating since early summer and has only shown modest strength recently compared to gold.
This strength is likely to dissipate even more as the Fed's rate hike campaign is likely nearer the end than the beginning or middle -- this seems certain given the campaign began in August 2001 and events of today, while much different in nature, are growing more concerning.
While the Fed stated it will remain "accommodative" and suggested again that rates could be raised at a "measured" pace, gold seems to be a caged animal ready to break through.
The next FOMC meeting is on Nov. 1, and perhaps the best opportunities to buy gold will be on any weakness as the result of these rate hikes which appeared to be numbered.
