Indicator Signals It's Time to Invest in Precious Metals... But Not the One You May Think

The bear market in gold may not be over, but one precious metal is a buy now.

Before getting to that buy, I want to talk about Japan. Two weeks ago, I explained how trading once every two weeks can increase returns. Last week's market crash in Japan immediately put that theory to the test.

With detailed testing, I have found that trading as little possible with a relative strength (RS) system can generally increase returns. In a RS strategy, the idea is to hold winning trades as long as possible.

This often means holding even when the market pulls back or suffers a sharp decline. In hindsight, many of these pullbacks will turn out to be buying opportunities in a long-term uptrend. Sometimes, the decline is the start of a bear market and the RS system will confirm that with a sell signal within a few weeks of the top.

In testing, I found that holding after a sharp drop in price is almost always better than selling into a panicked market.

Panic is a good word to describe the Japanese stock market during the past week. A large one-day drop turned into a three-day decline of more than 12.5% in the Nikkei 225, a benchmark index for the Japanese stock market.

The Japanese stock market had been among the strongest in the world, and in early May my 26-week rate of change (ROC) system identified WisdomTree Japan Hedged Equity (NYSE: DXJ) as a "buy." This ETF fell almost 12% as the Nikkei fell, but it is still a "buy."

Every time a large price drop occurs, volatility increases. This pattern is why the CBOE Volatility Index (VIX) is also known as the "fear index." Price drops lead to panic selling, and traders believe that the bottom tends to occur when fear is at its maximum. When a crash occurs, the panic is often short-lived and prices quickly resume their uptrend.

[Note: With stocks making new highs daily, many investors are worried the next market crash is around the corner. And it could be. Check out my free report, 3 Indicators That Flash 'Sell' Before a Market Crash. For immediate access to this report, click here.]

That is one reason why it makes little sense to sell immediately after a crash. Selling locks in the losses and takes away the opportunity to participate in any recovery. Testing shows that a rebound is more likely than a continuation of the decline, which means statistically it will usually be best to hold in the weeks after a crash.

For now, RS in still high in DXJ and that ETF remains a "buy" even after the losses of the past week. That may change in the weeks ahead, but trading a system means following the rules and staying in a trade as long as the rules dictate.

A surprise in my system this week was a buy signal in ETFS Physical Palladium Shares (NYSE: PALL). After months of being on the sidelines in the precious metals market, my system is showing that it is time to get back in. This could be a short-term bounce in an extremely oversold sector, but PALL has broken out of a year-long consolidation pattern.

Prices actually fell back into the pattern after the initial breakout. Chartists call this a throwback, and many argue that it increases the reliability of the pattern. The buy signal I am following is based on the 26-week ROC, but it always nice to see a price pattern and other indicators confirm the signal.

Within the precious metals sector, palladium is the only metal with a bullish pattern at this time. More popular metals like gold and silver are still in downtrends but could enjoy short-term bounces. Only palladium is a long-term buy.

Recommended Trade Setup:

-- Buy PALL at the market price

After buying PALL, the portfolio will be holding three positions. I will update this table in two weeks, and by then we should have a clearer picture on DXJ.

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