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Dow Theory Update For January 17: Secondary Bullish Reaction Signaled For SIL And GDX

Jan. 17, 2014 5:40 PM ETSPY, DIA, IYT, GLD, SLV, GDX, SIL
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Seeking Alpha Analyst Since 2012

Co-Editor of the top-ranked investment  Letter  thedowtheory.com

Investor and Trader As an investor I'm deeply influenced by Dow Theory, especially by the book "The Dow Theory for the 21st Century". I focus on the primary trend (1-2 years). My trading is short-term based (avg trade duration 4-5 days).

In addition to US stock indexes, I have successfully expanded the application of the Dow Theory to precious metals, their miners, and US interest rates. The Dow Theory is a more accurate timing device that moving averages, breakout systems, etc.

Primary bear market remains unchanged

Today is one of these scarce days when a Dow Theory relevant event occurred. However, since one never knows which day will be the relevant one, the Dow Theorist is advised to keep an eye on the markets on a daily basis. Read below our comment for SIL and GDX (the gold and silver miners ETFs).

US stocks

The Industrials closed up. The Transports and the SPY closed down. Two days ago the Transports managed to better the last recorded closing highs (December 31). However, the SPY and Industrials failed to confirm. The longer price action remains below such highs for the SPY and Industrials, the higher the odds for a secondary reaction to develop.

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

The primary trend was reconfirmed as bullish on October 17th and November 13th, for the reasons given here and here.

Gold and Silver

SLV, and GLD closed up. For the reasons I explained here, and more recently here, I feel the primary trend remains bearish. Here I analyzed the primary bear market signal given on December 20, 2012. The primary trend was reconfirmed bearish, as explained here. The secondary trend is bullish (secondary reaction against the primary bearish trend), as explained here.

As to the gold and silver miners ETFs, SIL and GDX closed up. The primary trend is bearish, as was profusely explained here and here.

The secondary trend turned bullish today. I have been warning in the last few days (i.e. here) that we were nearing a secondary (bullish) reaction for SIL and GDX. Today, under the Dow Theory, we can say that a secondary reaction has been signaled. Why?

1) Both ETFs have been rallying since 12/23/2013, which is more than 10 days.

2) Both ETFs have rallied more than their minimum volatility thresholds, namely, SIL 16.27% and GDX 14.41%, whereas a minimum movement of 11.27% was required for SIL and 12.53% for GDX.

Therefore, both the time and extent requirements for a secondary reaction have been met.

As readers of this Dow Theory blog know, when one is dealing with stock indices such as the Industrials, the minimum meaningful movement to consider the existence of a secondary reaction is 3%. However, given that SIL and GDX are much more volatile than indices like the Transports or Industrials, we have to conduct a volatility adjustment that takes into account their higher volatility. In other words, whereas a 3% movement in stock indices is meaningful and tells us that something is happening; such a movement in SIL or GDX is merely noise given their higher daily volatility.

To calculate the volatility multiplier we take the 30 days average of the daily volatility (percentage change) of the SPY. We do, likewise, with SIL and GDX and divide SIL and GDX volatility by SPY's volatility. Once we have the multiplier, we apply it to 3% (the minimum volatility for the SPY for a meaningful movement) to determine the minimum movement for SIL and GDX. The spreadsheets below give you the full math:




SPY 0.004508   SPY 0.004508
SIL 0.016934   GDX 0.018831
Mult 3.75643301   Mult 4.17724046
Min mov 11.269299   Min mov 12.5317214

Thus, SIL should move at least 11.27% and GDX 12.53% for a movement to be relevant under the Dow Theory.

Let's see how much have SIL and GDX rallied from the 12/23/2013 lows:



Rally high (Jan 17) 12.29 23.33
Prim Bear Mkt low 10.57 20.39
Total advance 0.16272469 0.14418833

So both SIL and GDX have amply exceeded the minimum movement. Since it has been a confirmed rally, and this rally has lasted enough time and has had sufficient magnitude, we conclude that the movement since the 12/23/2013 lows is a secondary reaction against the primary bear market. By the way, the volatility adjustments I calculate when I am not dealing with stocks indices did indeed keep me on the right side of the market during 2013, as many false signals were avoided. If you are interested in seeing the Dow Theory out performance in SIL, GDX and gold and silver in 2013, please read this post.

Please mind that the primary trend remains bearish. We are just witnessing a secondary bullish reaction against a primary bearish trend. Of course, the first step towards a primary bull market is a secondary reaction against the primary bear market; however, we shouldn't underestimate the power of the primary trend. So the ongoing secondary reaction merely tells us that the odds favor in the weeks ahead somewhat higher prices (that is the continuation of the reaction) within the primary bearish trend. Here you have an updated chart:



The blue rectangles highlight the ongoing secondary reaction against the primary bearish trend

By the way, while this does not belong strictly to the Dow Theory arsenal, it is noteworthy that today both SIL and GDX have closed above the red horizontal line (which was the level at which a primary bear market was signaled a couple of months ago. I find this is a bullish accomplishment that slightly skews the odds in favor of the continuation of higher prices in the days ahead.

Readers of this blog know that secondary trends are not dependable enough to be traded (at least not by me), and that we align ourselves only along the primary trend. Accordingly, I don't advocate for any long position in SIL and GDX yet.

Observation: Now we have both gold and silver and their miners in a bullish secondary trend. While this does not amount to a primary bull market; it is certainly pleasant to see that now the whole precious metals' universe seems to be in unison. I like to see inter-market confirmation.


The Dow Theorist

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