Stock Market and Gold Correlation

Apr 23, 2008: 12:16 PM CST

Intermarket analysis is a fascinating branch of market research, and I wanted to show you the performance of gold and the US Stock Market.

There’s been an inverse relationship, such that when gold rises, the market is generally falling and vice versa.

Gold is traditionally seen as a hedge against inflation, and inflation typically is seen as being negative for the stock market.

Also, in uncertain economic times (especially with a falling US Dollar), gold is a more attractive investment than US Stocks and so the two asset classes, much like stocks and bonds, compete for your investment capital.

This correlation holds on the longer time frame charts as well:

Notice that gold prices in 2006 around $600 were not a problem for the stock market. As signs of recession began to emerge, and investors began to be ’spooked’ by deteriorating financial conditions, larger investors likely began rotating out of the US Stock Market and into other markets such as gold, bonds, etc.

We see the rotation accelerate as the stock market began to fall going into 2008, when the price of gold ’skyrocketed’ from just under $700 per ounce to over $1,000 per ounce in March 2008. The S&P fell from a peak of 1,575 to just above 1,250 during the same period.

The recent fall of gold prices has contributed – with other factors – to a rise in the current stock market since March.

While there may be some correlation between gold prices and the US Stock Market, gold prices are much more inversely correlated with the US Dollar Index.

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Stock Correlation with the 10 Year Yield

Apr 23, 2008: 6:58 AM CST

I’m not sure how much you follow intermarket correlations, but there’s one relationship I’d like to highlight to you.

The S&P 500 Index has been extremely correlated with the 10 Year Treasury Note Yield ($TNX), and continues to be so today.

Generally (as demonstrated over the last 100 years, but not over the last 10 years), rising yields are bad for the stock market and falling yields are good for the stock market, but yields and the S&P market have traded near lock-step since just before 2008 began.

Recall that bond yields are inverse to bond prices, so there are implications here for the bond market as well. Bonds and stocks often compete for investor funds, and assets flow back and forth between these markets.

Notice that on the recent rally (from Mid-March), Yields have risen with the market, meaning bond prices have fallen, adding to the correlation (money has flown out of bonds and into stocks, driving yields down).

To show you how recently the correlation began, let’s view a weekly chart:

Let’s pull it back to 2000 on a monthly chart:

Notice how the 10 Year Yields follow the stock market decline from 2000 into 2003 swing for swing.

Also, notice that 10 Year Yields hit the same level they did near the 2003 stock market bottom.

As yields fell along with stock prices, investors shifted more and more into bonds (causing bond prices – not shown on these charts – to go higher).

It’s a fascinating correlation, and one to which you might want to pay attention.

(Rates closed today at 3.72% – that’s what the $37.20 on the left side of the chart means)

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A Day of Divergences and Interesting Trades

Apr 22, 2008: 9:20 PM CST

As I always recommend, take a look at your chosen market and chosen time frame and annotate the action and ideal trades for the day, so you can better analyze these patterns in real time.

Let’s look at the DIA (Dow Jones ETF) on the 5-minute chart (any of the 3 major US Stock Indexes have similar intraday patterns).

Let’s take it point by point.

The day opened up with a downside gap of 30 Dow Points, which would lead you to enter a ‘gap fade’ trade. Unfortunately, this trade didn’t ‘work out’ as expected and many traders had their stops hit.

1. A large resistance area, and moving average overlap trade (combined with a new momentum low ‘impulse sell’ trade) triggered a potential ’short-sell’ entry (target: intraday low or just beyond)

Price then began to falter beneath the key 20 period moving average, and with negative breadth, led you to continue to trade to the short side.

2. Annotation #2 identifies what I call an “F You!” trade (for those who are curious, the “F” stands for “fade“). I was short going into this trade and had a tighter stop than I should (combined with a larger position than I should) and a quick upthrust in price nailed all ‘properly placed’ stops and zapped away positions in less than a minute. Actually, ideal stops should have been placed beyond the falling 50 period average, but in the heat of trading, we don’t always do what we should.

I’m fine with stops, but not fine with trades that complete an “F You” pattern. This occurs when there is an obvious set-up and obvious stops that quickly comes up and fills the liquidity of resting stop orders and THEN reverses extremely rapidly and quickly back IN the direction that people expected. This development tends to frustrate traders and sometimes disillusion them.

These occurrences are rare, but if you miss them, then they can provide elegant entries. I had to chase the market down, which also was probably unintelligent, but this is why I write “idealized trades of the day” – to allow me (and you) to see patterns in calmer times outside market hours so that we can recognize them and trade them with confidence during market hours.

3. Following the large downward impulse (as expected), there was a slight retracement that resembled a 45 degree angle. That’s a bear flag! The flag broke down just before reaching resistance and achieved its price target, which wound up being the intraday low

4. Price also retraced to the falling 50 period moving average, setting up the potential for a ‘final’ trend trade as price began to build a base to trade higher and reverse. Notice the numerous positive momentum divergences that developed through the day.

5. Finally, price consolidated beneath the key 20 and 50 period moving averages, and this highlights how MAs can serve as support and resistance. Also, breakouts from consolidation can lead to higher prices (especially following positive momentum divergences).

Today was a great and interesting day that – like most days – provided many opportunities for profit. Print out your favorite chart and market and annotate it based on your understanding of trade set-ups and likely price behavior so that you can be ‘quicker on the draw’ during the trading day.

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Announcing INO TV in Detail

Apr 22, 2008: 10:05 AM CST

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AAPL Insights

Apr 22, 2008: 9:41 AM CST

Apple Inc (AAPL) completed its buy signal and is running into potential overhead resistance which could temporarily halt the growing up-move in the stock.

The buy signal I highlighted previously worked even better than I anticipated, with price gapping up multiple days to reach the first profit target – the resistance line at $170.

Traders, you may want to consider taking at least some profits at this level and waiting for a clean break above this level before trading higher, but that all depends on your strategy and risk-management parameters.

Also, I do want to highlight a divergence.

The recent move off the February lows has expanded each week on relatively lower volume, which is a technical non-confirmation of higher prices.

Let’s look at this two ways:

1. Higher prices are not attracting new buyers and the rally is suspect or at least due for a deeper retracement

2. The capitulation bottom of early 2008 zapped away all the ‘weak’ holders in a climax reversal, and so this must be considered when addressing ‘relative volume’

In other words, there’s no way to match or exceed climactic volume – this would be the more optimistic approach and the first statement would be pessimistic.

Keep your eye on this stock and let’s continue to watch or trade the exciting emerging developments.

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