Why $21.22 Is Your Inflation Protection Level

Question is… has the bear market rally over the past two weeks been solid enough to generate new buy signals? Well, yes and no…

History Repeating?

While some indexes did establish buy signals, a number of them weren’t able to reach their optimum downside targets. While this is can sometimes create false signals, the bigger picture indicates that the signals are probably valid.

What is much more certain, however, is that the indexes are tracing out a larger consolidation pattern. That movement could mean that the Nasdaq indexes will test their January (and possibly even November) highs before any serious selling resumes.

Long-term consolidation patterns are nothing new for stock indexes. In fact, the current pattern on the S&P bears some striking similarities to the larger one that ended in 2002 – as you can see on the monthly chart below…

The main two similarities that jump out between these two bear market consolidation patterns is that…

• The selloffs began from almost the same levels
• Until March, the number of points lost was practically identical

The key difference between the two time periods, though, is that the 2000-2002 bear market lasted over 2½ years, while the current bear market is only in its 18^th month.

This means that even amid a strong rally at the moment, investors should be very wary about calling this the bottom and jumping back in with a vengeance. Bear market rallies often lure investors back to the party with quick, sharp upward moves… only to run out of steam and head back down.

Practice Patience During March Madness

So don’t expect a new bull market to start here. Before the five-year bull market that followed the last bear market, the indexes went through an eight-month consolidation pattern. And even if we use the November low as the start of the consolidation pattern, this one has only lasted four months.

In addition, when we see steep declines – as we have done recently – it usually requires a longer consolidation period while time plays catch up with price.

In 2003, we didn’t know that the market’s consolidation pattern was complete until weekly buy signals were triggered. And right now, it’s just too early to even consider calculating where the S&P 500 would trigger a weekly buy signal.

What we can say, though, is that since the Nasdaq 100 didn’t violate its November low, it would have to get up to at least 1,387 points just to set up a weekly buy signal.

Fortunately, we can be more definitive with this week’s sector…

Your Inflation Buzz-Phrase: “Trillion-Dollar Bailout”

Last week, the Federal Reserve announced that will buy $1.2 trillion worth of government bonds, which will then be pumped into the U.S. economy,

It wasn’t just stocks that loved the news. Commodities did, too. A lot! For example, gold prices shot $70 higher from Wednesday’s low. And most other dollar-denominated commodities were higher by the end of the week, alongside foreign currencies.

Hot on the heels of that strategy, the government revealed its own trillion-dollar move today. The “Public-Private Investment Program” will buy $1 trillion worth of so-called “toxic assets” in order to shore up U.S. banks’ sagging balance sheets.

Stocks may love all this trillion-dollar bailout news – in the short-term. But over the longer-term, most analysts agree that we’ll see something else rise soon: Inflation. Hardly surprising, with the U.S. mint continuing to run the presses at a rapid clip.

If we do indeed see that result, it means one thing: The value of the U.S. dollar has nowhere to go but down. And that will consequently force commodity prices higher.

Take a look at the daily chart of the PowerShares DB Commodity Index Tracking Fund (NYSE: DBC)…

As you can see, DBC closed above its 50-day moving average (marked in red) – the day before the Fed’s $1.2 trillion announcement. It then closed higher for the rest of last week.

The important number is $21.22 – the level it needs to close above in order to trigger a daily buy signal. If it can do that, it’s a very good area from which investors can buy into the broad commodities sector on pullbacks – something that would provide a good hedge against inflation, as well as price appreciation.

I suggest using a couple of closes below the trendline (blue) as a stop loss.

Source: How to Protect Your Portfolio from Inflation

Anyway, with Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) getting bailed out last week, Lehman’s bankruptcy comes at the same time as Washington Mutual (NYSE: WM) and insurance giant American International (NYSE: AIG) teeter on the edge of bankruptcy, too.

So now is the time to take a look at the latest carnage unfolding within the financial sector…

If You’re Investing In Financial Stocks… Here’s What You Need To Do

Despite the recent woes in the financial sector, it actually wasn’t faring too badly. Since the markets bottomed out on July 15, some banks have performed very well. Like BB&T Corp (NYSE: BBT), for example – up a whopping 82% – and US Bancorp (NYSE: USB), which has risen 64%.

Aside from the obvious major problems in both the bank and brokerage sectors, the brokerage stocks, which use more leverage in their businesses, seem to be getting the worst of it. For example, while USB was making a new two-month high last week, Merrill Lynch (NYSE: MER) traded at a 12-year low.

The moral of this story is this: If you’re going to trade the financial sector from the long side, you’d better do your homework and stick with these well-capitalized banks.

On the other hand, you can diversify and lower your risk from the sector through one of its most widely traded ETFs – the Financial Select Sector SPDR (AMEX: XLF)

As you can see below, the stock has remained stuck in a consolidation pattern since late July.

The Offsetting 85

However, this consolidation pattern is a bullish one – and for a good reason.

Because XLF is comprised of more than 85 stocks – mostly including banks, brokers, and insurance companies – when some of them are faring well and some doing poorly, the resulting action is sideways trade.

However, XLF appeared to trigger a daily buy signal off the July 15 lows and unless an alternative upside target is generated, the stock should eventually trade up to at least my minimum target around $24.40.

And that gives investors a good, low-risk opportunity to buy.

That’s because in the wake of the Lehman fallout, the stock will probably trade back down to the bottom of the consolidation pattern in the $19-$20 area. Beware, however…

A Financial World Still Crumbling

If you’re looking to invest in financials in hopes of grabbing some bargains, remember that the sector is still in crisis. Moreover, nobody really knows for sure if other institutions will stumble down the same path to bankruptcy as Bear Stearns and Lehman Brothers.

The best course of action is to wait for the dust to settle and see if XLF can hold the $19 area.

And on a broader scale, the S&P 500’s low for the year is 1,200.44. If the index closes below that level, it should have further to go – in which case, I’d hold off on buying anything until the dust settles.

Commodity Rewind… And Flash Forward

In the last couple of editions of “Sector Watch,” we’ve looked at some of the commodity sectors, including energy and gold, along with their related ETFs.

According to the analysis generated by the trading system I developed for my 1-2-3 Trader service, we noted that they all had bearish daily chart patterns.

And over the past couple of weeks, the US Oil Fund (AMEX: USO), SPDR Gold Trust (AMEX: GLD), and the US Natural Gas Fund (AMEX: UNG) have all made new correction lows.

In fact, USO and GLD have similar chart patterns and they reached my minimum downside objectives over the past week. With UNG, the chart is more complex and it’s hard to tell at this point if the “C” wave (or “3rd wave”) is complete.

Regardless, most of the commodity sectors are now reaching oversold territory and if nothing else, we can probably expect at least a decent rebound to work off the oversold conditions.

USO and GLD are now all set up for daily buy signals, so the risk of being short is increasing.

That also goes for the Powershares Commodity ETF (AMEX: DBC). Let’s take a fresh look at the chart…

We originally highlighted this chart in the August 25 edition of “Sector Watch.” At that time, the stock was trading above $38, and the “C” wave decline was just getting underway. Since then, the stock has made new correction lows and reached my minimum downside objective of $34.60.

So as I said, the same theory as USO and GLD applies here: The chart is set up to trigger a buy signal, so be wary of going short at this point.

We will revisit the commodity ETFs once we see what unfolds from here.

Take care till next time.

Jim

Source: If You Invest In Financial Stocks… Here’s What You Need To Do

In my last column, I pointed out that the United States Oil Fund ETF and natural gas ETF United States Natural Gas Fund were in the process of tracing out at least an A-B-C correction to the downside.

Click this link to check out the chart from two weeks ago. Since then, USO has rallied enough to qualify for the “B” wave rally. From here, there are basically two scenarios…

1. If the “C” decline has already begun, the stock should trade down to at least the $86.50 area.

2. If the “B” wave rally is not yet complete, and USO trades above last week’s highs, the next resistance level is around $100.95.

Either way, USO should make new correction lows before a sustainable rally could unfold.

Gas Still in the “A” Wave

The natural gas market has performed weaker than crude oil and made new lows again last Friday. This means that UNG is still in the “A” wave decline and alert investors could have an opportunity to short the stock on the first decent rally, which would be the “B” wave.

Aside from that, most commodities have endured heavy selling pressure since topping out in early July. We’ve seen oil trade below $112 a barrel and gold dip below $800 an ounce before both rebounded last week.

Part of the rebound came as a result of a pullback for the U.S. dollar. So since commodities are strongly correlated to the dollar – and that appeared to be the focus of many traders last week – I’m going to take a look at a couple of the most active and interesting-looking charts this week…

This PowerShares ETF Is Powering Down

The chart below shows the daily performance of the PowerShares DB Commodity Index Tracking Fund (AMEX: DBC). As you can see, it looks very similar to the USO chart.

In mid July, DBC triggered a sell signal – and based on the chart pattern, it appears to be in the “B” wave of at least an A-B-C decline.

If DBC and all of the ETFs mentioned above have put in major, long-term tops, these three wave (A-B-C) declines could actually turn out to be longer-term, five-wave declines. However, it’s too early to determine if that’s the case yet, so we’ll stick with what we know for now.

So if the “B” wave on DBC is complete, the stock should trade down to the $35 area before a sustainable rally could get underway.

When Three Waves Becomes Five Waves

This next chart caught my eye because it traded down to its long-term trendline last week and has so far held above it.

Because the commodity futures create more accurate charts, while the ETFs just follow their lead, I’m going to break with tradition a little bit and use a weekly chart of the December Gold futures (GCZ8) for analysis here, rather than the SPDR Gold Shares (NYSE: GLD) chart.

The trendline on this chart goes all the way back to July 2005 and you can see that it was tested when the futures price traded down to $778 on August 15. Since that low, gold has rallied by about $55, but we still haven’t seen any significant buy signals get triggered so far – something that would tell us that the correction is complete.

However, this development spilled into GLD, as the stock posted an equivalent low of $76.61 on August 15. This was also around the same time that the dollar peaked.

The sharp dollar rally was a mirror image of the drop in GLD and usually after this type of action, the odds are that these markets could consolidate before making their next major move.

The Next Moves

The price action over the next week or so should be a good indicator of where GLD is headed next. If GLD begins to consolidate in the $80-86 area for a while, there’s a good chance that once the consolidation is complete, the next move will be down – especially since DBC still looks bearish.

If GLD and the December Gold futures make new correction lows, the selling could intensify, as we’re not the only folks watching the long-term trendline. However, if GLD begins to rally strongly on heavier volume, and closes above $88.50, the correction may be over.

According to the trading model used in my 1-2-3 Trader service, we could see buy signals triggered on GLD prior to reaching the $88.50 area, so I’ll keep you posted on the situation right here.

Source: Let the ‘Waves’ Guide You Towards Profits on Oil, Natural Gas, & Gold