Wednesday, February 20, 2013

The decline and fall of fear

Consider the latest technical development for gold and the gold ETFs: for only the second time since 2001, the 450-day moving average has been decisively broken by the gold and gold ETF price lines.  What’s so important about this event you may ask?  Unlike the last time the 450-day MA was violated (briefly) during the 2008 credit crisis, relative strength for gold was increasing at that time. 

Moreover, trading volume expanded noticeably during the 2008 violation of the 450-day MA, which indicated both capitulation on the part of retail traders and heavy accumulation on the part of “smart money” investors.  This time around there is no such increase in relative strength, but rather a decrease in relative strength.  Trading volume has also diminished rather than expanded.

The following chart is courtesy of Don Hays Market Advisory.  Hays pointed out the relevance of the recent breakdown below gold’s 450-day trend line in a recent market commentary.  He has always referred to gold as the “Fear Index” based on his belief that the price of gold is primarily function of investor risk aversion at the expense of equities.

Indeed, the steady erosion of gold's price is part and parcel of the decline of fear that has been ongoing since last fall when the latest equity rally kicked off. My take on the "Fear Index" is that the decreasing fear is that the cyclical bull market for equities, while not over yet, could be fairly soon. Just as the early stages of the 2009-2013 market rally were characterized by high levels of fear, so the latter stages of a recovery are typified by declining fear. An accompaniment of tihs is declining levels of short interest, which in turn renders the stock market more vulnerable for negative shocks.

Today’s equity market is priced to perfection.  Anything that comes along in the next few months to undermine the status quo could become a catalyst for a trend reversal. 

Bottom line: stay bullish for now, but be careful where you tread.

No comments: