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Keep a close eye on this rally...
I remain of the mind that we are putting in some kind of top. We have had nine successive up weeks since March 8th. This is most unusual. Based on past rallies, a continuation of this up trend is less than 5% probable.
Nevertheless any sell-off is being met with eager buying. We saw it on April 21st and we saw it again yesterday, with the US indexes rallying strongly during afternoon trading after the morning declines.
So which way are we headed now?
This is not a new bull market
The rally we have seen over the last two months has been exceptional. I know these are exceptional economic circumstances – but they are exceptional because they are so bad. Yet a number of people are saying that a new bull market has begun.
It's possible, but I don't believe it. The underlying economic problems have not been solved. The banking system has not been reformed. Unemployment is soaring (just today figures showed unemployment rising to 2.22 million with another 244,000 people losing their jobs between January and March). Business is in recession. Even the political system has shown itself to be insolvent, at least morally, and in need of reform.
These are not the underlying fundamentals for a new bull market. Mother Nature will purge the system, no matter how much policy-makers fight it, no matter how much quantitative easing takes place, and the purging has barely begun. Bob Hoye of Institutional Advisors (www.institutionaladvisors.com) sent me this chart last week. It shows the time frame you should be looking at.
Based on previous economic contractions of this magnitude, we have at least another year – but probably three – before the economy bottoms out.
How long will the bear market rally last?
What we have seen is a bear-market rally, a traders' rally – a chance for some to recover losses and get out. Its remarkable upside violence is typical of a bear market rally. Its timing and magnitude is in keeping with the post-crash, 1929-32 model that regular readers will know I have been following. The March lows need to be retested – and they will be – before this long-term, secular bear market can be deemed over.
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Although sentiment indicators are now very positive, I was at an investors' lunch on Monday and the general consensus was that this was a bear market rally and nothing more. Murphy's Law would suggest that this rally needs to go a lot higher and suck a lot more people in before it rolls over, so one possible scenario I am considering is that we continue to rally into, say, July.
But even if we do, I still see at least a short-term pullback of 5-10%, taking us back to at least the 21-day moving average, if not the 55 day one. (That would be 4,000 – 4,200 on the FTSE; 870, or even 800 on the S&P 500). There are just too many forces at work: the fact that this rally has gone on for so long and for so far, and technical resistance on the charts and seasonal patterns. The next chart from Dimitri Speck of Seasonal Charts (www.seasonal-charts.com), showing the seasonal patterns of the Dow, shows the likelihood of at least a short-term stock-market sell-off in the second half of May.
Stock markets may be taking their time to roll over, but that is because the bears will have lost their nerve. Many of them will have been impaled over the last two months, while the bulls, who have made a lot of money, will be feeling, well, bullish.
Gold still looks good
Finally, it is worth noting the positive action we have been seeing in gold, silver and other resource stocks in recent weeks, particularly uranium (incidentally, there's more on uranium in this week's issue of MoneyWeek, out on Friday – click here to get your first three issues free). As you know, these are sectors I like and am excited about.
Nevertheless, I would expect resource stocks to correct with the overall markets, assuming this happens. However, gold stocks remain on course to be the best asset class of the next two years. The party has barely begun. A number of commentators have noted the massive, bullish inverted head-and-shoulders pattern that is taking shape in the gold chart (more on this another time). I am looking for another intermediate correction in gold, a tradable low in the June to August timeframe before the next big upmove. But that move may already have begun. If it has, it is something I am more than happy to be wrong about.
I don't like to talk about silver because I don't want to jinx the move, but she too has been creeping up nicely. There is likely resistance, however, in the $14-15 range, so be careful.
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Dominic Frisby
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