Watch That Dead Cat Bounce

Gil Morales and Chris Kacher
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Posted: Sep 20, 2011 12:01 AM

Signs are showing that the latest bounce which began on September 12 is a dead cat bounce for the following reasons:

1) Friday's options expiration resulted, as is typical on such days, in exaggerated trading volumes across stocks and indices. Short covering of positions has been evident while there has been lackluster buying of leading stocks. Further, very few leading stocks have formed constructive bases and are moving to new highs.

2) Both the price of oil and the CRB index which tracks the price of a basket of commodities is showing much weakness, both having undercut their 200-day  moving averages several weeks ago. This is an indication that demand on such commodities is weak and thus telegraphing that we could be headed toward a global recession.

3) The small cap Russell 2000 usually outperforms the large cap NASDAQ 100 in uptrends. Yet in the latest bounce, the Russell 2000 is underperforming. Thus our model's fail-safe in this case is being governed more by the Russell 2000 than by the NASDAQ Composite.

Ultimately, the fundamental backdrop continues to look as disturbed as ever. The Greek bailout situation is looking dire, and new Euro-dominoes could topple in the European fallout with countries that are "too big to bail" such as Italy and Spain. This could make the Lehman bankruptcy that occurred in the U.S. back on September 15, 2008 seem small by comparison.

The recent news that the Federal Reserve will be coordinating with the European Central Bank to provide loans has caused the much maligned stock markets in Europe to bounce, the euro to strengthen, and the dollar to reverse its short term uptrend. Money which flowed into gold as part of the fear trade has reversed back into the euro which has put short term pressure on the price of gold.

But because European banks needed to seek the help of the Federal Reserve, it also means that cash levels at these European banks is very low. Further, with more of this quantitative easing money printing shell game going on in both the US and in Europe, it only prolongs the problem of mounting debts. As we have said on CNN's Wall Street Shuffle, if the economy were a patient with a tumor, the central banks are pumping the patient full of morphine a la quantitative easing which makes the patient feel better in the short run, but ultimately does nothing to kill off the tumor which just grows larger.

As we have said, higher gold prices are in the offing in the long run. While gold will experience some bumps along the way, as has been the case since it began its long term uptrend back in 2001, its long term uptrend should remain intact. Silver, gold's cousin, roughly correlates with gold, so should also find price stability in this current basing pattern it has been forming, then eventually move higher. How long it takes to complete its basing pattern is anyone's guess. If price history is any guide, silver based for 9 months Dec '09 - Aug '10 before breaking out. SLV is currently in the fifth month of its basing pattern. However, the number of tailwinds that argue for higher prices in gold has risen so the basing pattern could complete sooner.

As for jumping on board 1-times, 2-times, or 3-times stock market index-based ETFs at this time, here is our answer:

http://www.virtueofselfishinvesting.com/faqs/answer/I-was-late-buying-an-ETF-when-the-model-switched-signals-Now-that-the-price-of-the-ETF-is-back-to-where-it-was-can-I-buy-now

http://www.virtueofselfishinvesting.com/faqs/answer/I-just-joined-The-suggested-ETFs-are-trading-higher-today-than-where-they-were-originally-recommended-Should-I-buy-an-ETF-now-or-wait-until-the-next-signal-change-to-act


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