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Market Outlook: Indicator Tells Us Not to Rule Out a Rebound in Gold

Stock markets jumped after the unemployment rate rose on hopes that the Fed will continue pumping up the economy. Those gains may fade this week.

What a Difference a Day Makes

After a 1.27% gain on Friday, SPDR S&P 500 (NYSE: SPY) snapped a two-week losing streak with a gain of 0.83% for the week. Friday's rally was spurred by new signs of a weak economy. In the long term, a weak economic outlook is not a solid foundation for a bull market.

In the short term, stocks became overbought after the employment report was released. This can be seen on the 15-minute chart shown below.

SPY Market Outlook Chart

At the bottom of the chart is the Traders' Dynamic Index (TDI), which uses the Relative Strength Index (RSI) and moving averages (MA) of RSI. MAs are used to smooth the fluctuations seen in the volatile RSI indicator. Bollinger Bands, also based on RSI, are added to highlight unusual extremes in market action.

On Friday, the 7-period MA of RSI crossed above its upper Bollinger Band about an hour after the open. Using 15-minutes bars, this happens about twice a month on average. There are about 520 15-minute bars in a month, so this signal occurs about 0.4% of the time.

Although this signal is relatively rare, it doesn't provide much information about the future direction of the market. In a typical week since 2007, SPY has closed higher 58% of the time. After the oversold TDI signal occurs, we only see gains 52% of the time. There is a slight downward bias for the next week but not a tradable edge.

What is useful about this signal is that SPY experiences significantly lower-than-average volatility in the week after the signal. On average, SPY moves only one-fifth as much as it does in a typical week. A repeat of this pattern would indicate that the following trading week should be relatively lackluster. If there is a large move, it could indicate the direction of the next major market trend.

Recommended Trade Setup:

-- Maintain long position in SPY
-- Maintain stop-loss at $159.80
-- Maintain price target of $176 by year-end

Gold Could Rally From Oversold Extreme

SPDR Gold Shares (NYSE: GLD) fell 0.48% for the week and had another very big move on Friday. Two weeks ago, GLD fell more than 2% on Friday. Last week also ended with a loss of more than 2% on Friday. TDI reached an oversold extreme about an hour after the open.

GLD Market Outlook Chart

GLD has a tendency to rebound in the week after this signal with gains coming almost 60% of the time. The average gain is about 2.3% with half of the gain coming the day after the signal. That pattern predicts a rebound in GLD in the first part of the week.

Friday is likely to be another big day for GLD. Economic news that day will include the Producer Price Index for May, which is expected to show a small gain of 0.1% compared to April. If inflation comes in higher than expected, GLD could jump.

Individual traders seem to have given up on gold, providing the sentiment backdrop for a bullish move. In the futures market, small speculators have decreased their exposure to gold by 95% since the metal peaked in 2011. Selling continues in GLD and the ETF now holds 32.4 million ounces of gold, down from 43.4 million ounces at the start of the year. An upward move in gold, against the expectations of many investors, should not be ruled out.

After a brief rally, gold is likely to continue lower as commodities in general seem to be in a long-term bear market.

This Week's News

With little news in the first part of the week, stock and bond markets should see lower-than-average volatility.

Michael J Carr Market Outlook