View From The Turret: Technical Resistance

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Includes: FCG, FDO, GDXJ, JCP, WLT
by: Mercenary Trader

By Mike McDermott

After spending nearly the entire month of January moving higher, the broad market is running into its first major technical challenge this year. CNBC has been showing a ticker of the Dow, showing in real-time how close the index is to breaking the 2011 high, and the S&P 500 is also entering the price range where last year’s rally stalled out.

So it was only natural last week to see equities slow their advance, and trade a bit lower on Thursday and Friday. Fundamentally, the minor pullback was blamed on a disappointing GDP number that showed growth below expectations. But the technical overhead resistance likely played a big part in the decline as investors lighten up exposure that has finally reached profitable levels from purchases halfway through last year.

This week, we turn the calendar page to a new month, and continue to sort through a full slate of earnings announcements. We’ve all read the Trader’s Almanac statistics about how January sets the tone for the entire year, and how the US election cycle creates a bullish background for equities this year. At the same time, economic uncertainty both domestically and abroad create plenty of overhead risks that offset the “statistical advantage” of a positive January in an election year.

All of these cross currents make for a very active trader’s market. New pieces of information are coming to the market daily, and being interpreted different ways by different parties. Long-term decisions invest in growth initiatives may sacrifice short-term performance (as in the case with Netflix Inc. (NASDAQ:NFLX)). A Greek restructuring may force debtholders to take a haircut, but lead to a more stable environment.

From our perspective as traders, we’re much less interested in forecasting how the trends will ultimately play out – and more interested in capturing profits from the price swings along the way. This falls in line with our theme of “being right versus making money.”

This week, we are watching the overhead resistance levels carefully, and focusing more on positions that have room to run before hitting key technical barriers. Fertilizer producers, gold stocks, and steel manufacturers all have plenty of overhead room before hitting the 2011 peak areas. There are also some good shorting opportunities setting up, should the resistance areas hold.

Below are a few of the areas we are most interested in this week…

Fed Juices Precious Metal Stocks

Last week, Ben Bernanke and Co. announced that they were committed to keeping interest rates at historical lows well into 2014. The Fed’s action cleared the way for gold stocks to ramp higher

This new rebound for precious metals – and the companies that produce gold and silver – comes at an interesting technical juncture. Since mid 2011, precious metals have been in a bearish pattern as the dollar strengthened and institutional investors gained more confidence in “traditional” equities.

Four to six months of fading action has helped to cool the gold bugs’ enthusiasm and reset the sector from a technical perspective. But with rates staying at low levels, and the Fed keeping its options open for more bond purchases, inflation concerns are once again rising.

The current environment is especially interesting for silver which has the qualities of both precious AND industrial metals. The broad economy continues to grow (albeit more slowly than expected), which drives demand for industrial metals. At the same time, inflation concerns drive demand for precious metals and silver fits both of those profiles.

The Mercenary Live Feed now has a number of positions in this area including a covered call setup mentioned in last week’s View From the Turret along with a few swing trades in precious metal miners.

As spot prices for precious metals ramp, small and mid-cap miners will benefit more than their large-cap brethren. Typically, blue chip producers have distribution contracts and hedges in place to insulate themselves from price swings. But small cap producers are more likely to be able to raise funding for additional development based on higher gold and silver prices – not to mention enjoying higher margins on current production.

The Market Vectors Junior Gold Miners (NYSEARCA:GDXJ) is a good proxy for small and mid-cap gold miners, and also includes exposure to silver producers. More importantly, a list of the ETFs components is a great place to shop for individual producers with good chart patterns and strong fundamentals.

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Middle Class Retailers Compete With Discounters

Last week’s announcement by JCPenny (NYSE:JCP) creates a new dynamic for discount retailers. The department store will be embracing a new pricing model where they will offer an “every day low cost” price point for all merchandise instead of the traditional model of high prices and regular mark-downs.

The company plans to make massive cost cuts (likely including a significant number of layoffs), and also beef up their marketing budget to drive more traffic.

JCPenny’s move is just one example of retailers moving down the value chain, catering to the budget-conscious consumer and abandoning the middle class market. It’s clear that more consumers are falling into this category (which is why retailers are serving this market), but more competition will reduce profit margins for the entire area.

Deep discounters like Family Dollar Stores (NYSE:FDO) have had good success over the last two years as consumers have migrated to cheaper outlets for goods. But now that the major retailers are encroaching on their territory, the advantage may be lost.

FDO has begun to trace out a topping pattern. Last week’s rally up to the 50 EMA (after falling early in January) sets up an interesting short opportunity. With the broad market running into resistance, FDO looks like an attractive short to help counterbalance bullish exposure. It’s one of the names we are watching carefully this week.

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Natural Gas Producers Vulnerable

Last week, Jack offered a contrarian perspective to the recent natural gas spike. Judging from some of the emails we received, the piece hit a sensitive nerve for a number of traders.

This month, our Global Trend Capture service took a nice profit on a bearish natural gas trade, and the area still looks ugly from a technical perspective.

Natural gas producers face an interesting dynamic in that they are able to produce more gas because of shale fracking techniques, but low prices for natural gas makes it more difficult to justify the drilling programs.

The First Trust ISE Reserve Nat Gas (NYSEARCA:FCG) ETF is a good proxy for natural gas producers – and the chart has been setting up a series of lower highs since the October rally. A break from this point would catch natty bulls off-guard as many believe we simply can’t go lower from here. A forced liquidation or panic flight could give the bears a pretty nice short-term trade – and the action could ultimately set an unexpected floor for the group once the last of the weak holders are flushed out.

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Options Spotlight

This week’s screen from the Mercenary Options Dashboard includes covered call setups that have a 70% probability rate of being assigned, expire in 50 days (the March contract), offer at least a 2.5% rate of return, and offer 15% downside protection at a minimum.

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There were a number of attractive trade opportunities that fit this criteria, but Walter Energy (NYSE:WLT) caught my eye particularly. The company makes coking coal which supplies the steel industry. This trade fits in with our bullish steel positioning, and offers a 19% annualized rate of return with a breakeven point at a clear support area on the chart (well below the current price).

Walter Energy hasn’t reported fourth quarter earnings yet, so the report adds additional risk to the covered call trade. But WLT will likely trade more on expectations for global manufacturing – rather than on past performance for the company.

The overall market opened soft Monday morning due to more concerns in Europe. Watch for the bulls to try to support this market (and manufacture a breakout), but keep that risk managed carefully.

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here: http://mercenarytrader.com/legal/