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Dow Theory Update For August 16: Secondary Trend For Stocks Turns Bearish

|Includes:DIA, GDX, GLD, IYT, SIL, SLV, SPDR S&P 500 Trust ETF (SPY)

Did GLD signal a primary bull market yesterday?

Yesterday I expressed my qualms as to whether GLD, by breaking up the 07/23 secondary reaction highs, had signaled a primary bull market.

Let's go back to the basics.

The most common Dow Theory pattern for a primary bull market signal is as follows:

1. Ongoing primary bear market.

2. Bullish secondary reaction against the primary bear market. Both indices must fulfill minimum extent and time requirements (i.e. 8-10 trading days).

3. Pullback of minimum extent in at least one index; negligible pullbacks are not to be considered. Thus, when dealing with stoks indexes, anything less than 3% is disregarded.

4. Breakup by both indices above the secondary reaction closing highs.

Thus, when dealing with stock indices we have hard-and-fast rules. One of these rules, which is vital to qualify pullbacks, is to require a movement exceeding 3%. Anything below this volatility threshold is considered noise, and should be ignored.

However, when dealing with gold and silver, I feel we cannot apply the "3% rule" without accounting for GLD and SLV greater volatility when compared to stock indices. A movement of 3% is significant for stock indices whose daily volatility normally doesn't exceed 0.5%. However, GLD, and more especially SLV, tend to have a much larger daily volatility. Consequently, I feel that the "minimum volatility threshold of 3%" should be increased accordingly for GLD and SLV.

Of course, here is where things get tricky. How do I measure volatility? Since we are not dealing with maths, but merely trying to gauge volatility conditions, I normally take it easy. I normally take 1 day percentage change (or one day standard deviation), and I average it for the last 30 days. I calculate it for the SPY (proxy for the S&P 500), and I do, likewise, for SLV and GLD. If, for instance, SLV doubles the SPY daily volatility, then the minimum movement, I will demand for SLV will be 2 x 3 % = 6%.

If you look at the chart below, we can see that following the 06/27 primary bear market lows, GLD and SLV staged a rally. Such rally fulfilled the Dow Theory requirements for a bullish secondary reaction. More importantly, such rally, after accounting for GLD's and SLV's larger volatility, had enough magnitude and was not "noise." You can find the volatility adjustments I performed here.



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To the best of my knowledge, the primary trend remains bearish in spite of the solid secondary reaction
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The secondary reaction highs were made on 07/23. Then we had the awaited pullback which ended on 08/06. How much did GLD and SLV lose from the 07/23 secondary reaction highs? Here you have the answer:



  GLD SLV Date
Sec React high 129.71 19.77 July, 23
Pullback low 123.97 18.83 August, 06
Pctg decline -0.04425256 -0.04754679  
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Thus, both GLD and SLV failed to decline by even 5%.

Of course, if we were dealing with stocks indices and their concomitant lower volatility, we would have had a "qualified" pullback. However, GLD's and SLV's volatility is roughly 2 and 3 times larger than SPY's, respectively.

I have calculated volatility in four alternative ways so that I am sure that I am really making a good assessment thereof. Thus, I have calculated:

1. One day percentage change of prices averaged for the last 30 days.

2. One day percentage change of prices averaged for the last 100 days.

3. Three-day percentage change of prices averaged for the last 100 days.

4. 10-day percentage change of prices averaged for the last 100 days.

Here you have the resulting volatility readings:

GLD's volatility:







  1 day volt 1 day volt 3 days volt 10 days volt
  (30 days avg) (100 days avg) (100 days avg) (100 days avg)
SPY 0.0044 0.0054 0.0095 0.01825
GLD 0.01 0.01 0.018 0.0385
Multiplier 2.272727273 1.851851852 1.894736842 2.109589041
Minimum Volt 6.818181818 5.555555556 5.684210526 6.328767123
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SLV's volatility:







  1 day volt 1 day volt 3 days volt 10 days volt
  (30 days avg) (100 days avg) (100 days avg) (100 days avg)
SPY 0.0044 0.0054 0.0095 0.01825
SLV 0.017 0.0159 0.0303 0.053
Multiplier 3.86363636 2.944444444 3.189473684 2.904109589
Minimum Volt 11.5909091 8.833333333 9.568421053 8.712328767
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If you look at the "multiplier" you can see that no matter how we cut it, the decline experienced by GLD and SLV does not reach the minimum volatility threshold (i.e. 5.55% for GLD, and 8.83% for SLV).

Thus, I feel bound to appraise the current higher highs as merely the continuation of the secondary reaction against the primary bearish trend. Furthermore, we should bear in mind that secondary reactions can last some months.

Thus, bearing in mind that we are dealing with a "young" secondary reaction, and the pullback experienced does not reach the minimum volatility thresholds (in spite of calculating 4 alternative measures thereof), I am bound to conclude that:

a) The higher highs we have seen, merely confirm the secondary trend as bullish. This is bullish, and suggests that the odds favor higher prices in the weeks ahead (but not in the "months" ahead, if we were dealing with a primary bull market). It is "bullish" on the second degree, but not "bullish" on the first degree, which would entail a primary bull market.

b) Thus, the primary trend remains bearish.

c) From this new higher level in the ongoing secondary reaction, we can still wait for a "volatility-qualified" pullback. If after such future qualified pullback the new higher highs were made, then we would get the primary bull market signal.

d) As I wrote here, even in the absence of a qualified pullback, if the secondary reaction highs of 04/29 (NYSEARCA:SLV) and 04/30 (NYSEARCA:GLD) get broken up, we would get a primary bull market signal (alternative signal). While infrequent, this is a fully orthodox Dow Theory signal, which was mentioned by Rhea. The levels to be broken up are shown on the chart with the deep-blue horizontal lines.

I am not oblivious to the fact that Richard Russell, of the "Dow Theory Letters," yesterday declared a bullish breakout on the point and figure chart for GLD. However, my own understanding of such a chart is that such bullish breakout portends higher prices in the weeks ahead but lacks the magnitude for a real primary bull market. Russell sees a price objective of 1400 on the charts. If he had found a real primary bull market, the price objective should be much higher. In other words, indirectly Russell may be agreeing with me that GLD is turning bullish, but not so bullish as to be in a primary bull market. Time will tell.

Of course, nothing is written in stone, and subsequent price action could show that I am being too "orthodox" or inflexible when interpreting the Dow Theory. However, there is one factor that favors sticking to the rules, namely the existence of an alternative (and not so distant in the charts) primary bull market signal, as I have explained under "c" above. I rather prefer to miss some additional ca. 7% (for GLD), and wait for an undisputed primary bull market signal than bending my own rules. Furthermore, if GLD and SLV are to enter a primary bull market, and given their higher volatility, the odds favor a movement that could well reach 80%. So I am in no hurry.

Finally, we should consider that the benefit of the doubt corresponds to the primary trend in force. And this primary trend is bearish.

Of course, all this talk about the primary trend for GLD and SLV is just for short-term investment purposes (let's say a maximum of two years). If one has a secular view on gold or if one expects a "reset," all this talk about the primary trend of GLD and SLV is superfluous. If one has a fundamentally-based view on gold, and this view is bullish (i.e. based on FOFOA) one should stick to physical gold, as I have explained here.

I am so meticulous when it comes the proper labeling of SLV, and more importantly, GLD action, because I know that what happens to GLD's price in the coming weeks can be momentous. Here I have to give you some more background.

As you know, when it comes to my fundamentally-based ideas for gold, I am an ardent follower of blogger FOFOA. If FOFOA is right, and as ANOTHER put it (to know more about "ANOTHER," go to FOFOA's blog) "all paper will burn," which means, that eventually paper and physical gold will decouple. The consequences will be nasty for paper gold holders. Paper gold may lose lots of its value, thus reflecting the lack of physical to back it, whereas physical gold, after a closure of the markets, will reemerge with prices beyond belief (there is talk of USD 55,000 in current purchasing power).

While I feel that FOFOA's construction is fundamentally right, and that every individual subscribing to his thesis should be the owner of physical gold and not trade it (not even under the Dow Theory), it is clear to me that the fortunes of paper gold tell me a lot as to whether the decoupling is nigh or not. When/if paper gold nears its demise, we should see a vicious primary bear market set in (or at least, in case silver trends up), a blatant lack of confirmation by GLD.

On the other hand, if the time is not ripe yet for the advent of "physical-only" gold, we could see (paper) gold entering a new primary bull market, as the TPTB bought more time.

Of course, a primary bear market in paper gold does not necessarily imply that "physical-only" gold markets are near. What if it were a primary bear market for both paper and physical gold? What if the Chinese start dishoarding? Then we could get a primary bear market in both paper and physical gold. Thus, declining prices are not useful in order to time the advent of physical-only gold, or "freegold" as labeled by FOFOA. While declining paper gold prices makes us, followers of FOFA, suspect that the "end is nigh," we could be wrong.

On the other hand, strong paper gold displays a powerful message, namely: Paper gold is not ready to die. If TPTB managed to control the flow of gold, they could pull it off once again.

I derive an additional cue from GDX and SIL, the gold and silver miners ETFs. FOFOA contends that gold miners will not be allowed by governments to benefit from the windfall of USD 55,000 gold. Thus, he expects the miners to severely underperform physical gold. If the emergence of "freegold" were imminent, I'd expect GDX (and even SIL, for reasons to be learn at FOFOA's) not to be in a raging bull market. A primary bull market for GDX and SIL tells me that the status quo is not in jeopardy, which by implication means that paper gold is not ready to die.

Thus, if both GDX and GLD were in a powerful primary bull market, I'd tentativel conclude that paper gold has been given a breather, which implies that the end is not nigh…yet.

Of course, I'd never trade around a physical position in gold. If one believes that gold is predestined to go to the moon, I'd never run the risk of trying to "time" my entry, as it may prove to be too late (lack of physical supply or closure of markets). Thus, all my musings about physical gold, GLD, GDX, etc. are merely personal reflections as to the timing of an event which I am not interested to "time", namely the birth of "freegold".


The SPY, and Industrials closed down. The Transports closed up.

The primary trend is bullish, as explained here, and more in-depth here.

The secondary turned bearish. Therefore, we have an ongoing secondary reaction against the primary bullish trend, since:

a) Two indices (the Transports and the Industrials) have lost more than 3% since the last recorded bull market closing highs (08/01 Transports, and 08/02 Indutrials). The SPY has lost -2.995% since its 08/02 closing highs, which amounts to -3%, even though it was not necessary for the SPY to confirm, as just two indices are enough.

b) The decline lasted more than 8 trading days, more than ten calendar days, and has even reached the threshold of 10 trading days. So the time requirement has been fulfilled any way we cut it.

Accordingly, the movement we have seen since the last recorded primary bull market highs is now labeled as a secondary reaction against the primary bull market. The secondary trend is accordingly bearish.

Look at the chart below. The orange rectangles highlight the ongoing secondary reaction against the primary bull market.



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Secondary reaction against the primary bullish trend
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Today's volume was higher than yesterday's. Since stocks closed down, expanding volume has a bearish connotation. For the reasons I gave here, I'd say that volume is bullish in spite of the last two days of bearish volume. Furthermore, the last breakup of 08/01 was a bullish pivot, as was explained here.

Gold and Silver

GLD and SLV closed up. For the reasons I have given above, I feel the primary trend remains bearish. Here I explained the primary bear market signal. The trend was reconfirmed bearish, as explained here. The secondary trend is bullish (secondary reaction against the primary bearish trend), as explained here.

GDX and SIL closed down, and, unlike GLD and SLV, are unambiguously in a primary bull market under the Dow Theory, as explained here and here. The secondary trend is bullish as well.

Later today, or tomorrow, I will post a new episode of my saga "Face off: Schannep versus "classical" Dow Theory". Readers of this blog stay tuned, as I will deliver groundbreaking information.


The Dow Theorist