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The stock market has not made a decisive breakout yet, but gold has.
Volatility Points to a Possible Decline in Stocks
SPDR S&P 500 (NYSE: SPY) closed down 1% last week. On Friday, the ETF fell 0.63%, the fourth day in a row with a move larger than 0.5% (in absolute value). On an average day, since 1928, the S&P 500 has moved an average of 0.02%. A 0.5% move is 25 times greater than average and four in a row is an unusual pattern.
In the history of the S&P 500 index back to 1928, volatile periods like this have occurred about four times a year, on average. The index has a downward bias over the next week and the next month. Over those time frames, traders would have enjoyed a small profit, on average, from a short selling strategy.
Testing 100 years of data with the history of the Dow Jones Industrial Average shows the same pattern. Returns are below average after this pattern is observed.
Pattern analysis confirms a slightly bearish outlook. On both weekly and daily charts, SPY looks like it is forming a potential top.
Given the chart patterns and the extreme volatility seen last week, it is likely we will see this pullback continue in the next few weeks. Until the pullback becomes more serious, long positions should be maintained.
Recommended Trade Setup:
-- Maintain long position in SPY-- Maintain stop-loss at $159.80-- Maintain price target of $176 by year-end
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Gold is a Short-Term Buy
SPDR Gold Shares (NYSE: GLD) gained 0.86% last week. In the futures market, gold has been holding support after reaching a price objective defined by the top formed last year. Commercial traders are now more bullish than they have been at any time in the past two years.
Commercials are gold miners and other traders who know the industry better than anyone else. Miners could be bullish because they are aware of changes in demand, or they might know that supply will be tightening. Their timing is not perfect, but it is useful.
Activity of commercials in the futures market is shown as a green line at the bottom of the chart above. Raw data from the Commitment of Traders (COT) report has been converted to an index so it is easier to understand. High values are bullish and low values are bearish. Hedge fund activity is shown as the black line. They are more bearish than they have been in two years.
The next chart shows the positions of small speculators in the market. These are individual traders and smaller hedge funds. This chart shows the raw data from the COT report, which is the net position in contracts. In the most recent report, small speculators were short 683 contracts. This is the first time they have reported a short position since 2001.
In the past, buying when small speculators were short as a group would have been profitable over the next month. Three months after small speculators built up a short position, gold has been higher 62.5% of the time.
With several reasons to be bullish on gold in the short term, ProShares Ultra Gold (NYSE: UGL) is a buy. UGL is a leveraged fund and should move twice as much as gold on any trading day.
-- Buy UGL up to $59-- Set stop-loss at $54-- Set initial price target at $64 for a potential 8% gain
This Week's News
A Federal Open Market Committee (FOMC) meeting could be the market-moving event this week.
How the market resolves an indecision area this week could end up being the springboard for a new trend.
A bearish reversal in the face of broader market strength tells us this chemicals maker is in trouble.
Britain's departure from the EU adds another risk to the precarious market state we've benefitted from twice already.