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January 17th, 2005

Written by Matthew Frailey - matt@breakpointtrades.net


1. Administrative Comments: - continually carried over

Big announcement, we are current re-designing the Breakpoint Trades website, and the result will be a much better and far more useful website:

The new website will still be a month or more away, therefore I'm not going to go into too many specific details at this time, however here is a little information to get you excited...

- The website will be reorganized and will flow much better. Many new subscribers initially have problems understanding the layout of the current website, this will be rectified.

- There will be an integrated chat room, thus it will be easy for members to access the chart room and not have to download software, etc.

- A new partner has joined Breakpointtrades who brings 20 plus years trading and investment experience to you. He has been trading full time for a living since 1987, but prior to this time, he worked on wall street before that in the structured securities area. He is also currently the chairman a resource mining company.

- The new website will be muti-tiered and will offer two levels of membership: One level will be just as it is now but also improved. However the second level will offer far more, and will be aimed at the professional trader/investor. Our new partner will be maintaining this section.

Keith Kern will continue his current duties i.e. the daily watch list as well as the chat room. Though improvements will be made to these sections for your benefit.

Myself (Matthew Frailey) will continue writing the newsletters (but they will also be emailed) as well as the gold section, insider setups, and market sectors pages.

- etc. etc. etc.

More details will be given once we are close to launch....2005 will be a big year for Breakpointtrades, and you'll want to make sure you come along for a very profitable ride!

Gold and Precious Metals Analysis:

I typically discuss gold and precious metals last, but this week I will discuss them first because Gold metal and gold based stocks are really starting to look interesting here: I will present several versions of gold metal charts to show you that gold is reaching support levels and may soon rally:

Gold Chart #1 - 65 week moving average acts as support level:

After hitting a new high in late November near $455, gold metal entered a strong correction. The following chart is interesting because it shows that gold historically has strong support near the 65 week moving average. As you can see, gold metal is finally nearing this support level. There is a good chance that gold may find support near, or even slightly below this moving average.


Gold Chart #2 - Gold Commercial Short position:

This next chart is very informative and interesting to me and contains a lot of information: the 65 week moving average, an uptrend line, ABCD waves, and commercial trader net short positions.

As you can see, the commercial traders have been very accurate at predicting tops and bottoms in the gold market. Notice that during gold tops, the average short positions by commercial traders were typically 2 to 3 times higher than during gold bottoms. Obviously, it is prudent to listen to the commercial traders when playing the gold market.

Currently, gold is in a correction (after the large commercial short in late November of 178K) and is fast approaching the support uptrend line. The good news is that the current net short position is now about 108k - so it is coming down quite nicely. However, I would like to see the net short position fall to between 30k - 60k to be certain a bottom is in. Keep in mind that the data I receive is about a week old: Therefore, it is probably lower then 108k currently and will likely bottom before it is reported.

***Note, to compute the current value, subtract the commercial long position from the short position to get the total net short position. see the following link: CFTC Commitment of Traders

Anyway, as you can see, gold is looking more interesting everyday and may try to begin a rally near the uptrend line. Everything seems to be lining up nicely.


Gold Chart #3 - Elliot Wave:

I am not an expert on Elliot Wave, and I only know a few of the basics. There are two basic Elliot Wave patterns; a 5 wave pattern or an ABC 3 wave pattern.

The recent correction that began in early December either looks like an ABC correction or a 5 wave pattern. If the pattern is an ABC correction, then the fall in gold ended with wave 3 and has now entered an uptrend.

However, I do not think this is an ABC correction, I think it is a 5 wave pattern. Therefore, as you can see, gold has one more leg down (wave 5). I think gold will soon enter wave 5, which will take it down between the $400 - $410 area which will be the final bottom in this gold correction. In a 5 wave pattern, the 5th wave is always shorter then wave 3, and typically about the same length as wave 1 - this all correlates with my target above.

Also notice how this target range correlates nicely with everything else: The 65 week moving average and the 200 day moving average, the commercial net short positions, the muti-year uptrend line, etc. Everything just seems to be falling into place.


However, the US Dollar is key to the gold market as a strong inverse correlation exists between the US Dollar and Gold.

The US Dollar has been rallying since December as it was way oversold, but there is resistance in the 84.5 to 85 range, was well as the 200 moving average near 87.

Also, as you can see, there is a possible bearish rising wedge forming in the Dollar, therefore this Dollar rally may soon end. A break down from this bearish wedge would be bullish for gold.


Here's a longer term weekly chart of the US Dollar:

This chart gives us a different perspective: As you can see, the weekly stochastics are still oversold and have just begun to turn up and the MACD is just beginning to cross up. Therefore, I do not think the 85 level will stop the Dollar rally. I think the Dollar has a good chance to rally all the way up to the 200 moving average near the 87 level. This could take several weeks or more to occur, this amount of time is also needed to get the weekly stochastics overbought once again.

I think gold metal and especially the stocks will likely rally before the Dollar finally tops out. In other words, they will anticipate a Dollar top and rally before the top is actually hit.

The opposite of this occurred last fall:

Last fall, the Dollar was falling to new lows nearly every day, however gold stocks were either barely going up or fell during this time. In other words, smart money in gold stocks were anticipating a coming rally in the US Dollar, which is the reason they did so poorly last fall, despite the decline in the US Dollar.

Therefore, I think this time the opposite will occur: The smart money will anticipate a top in the US Dollar before it actually occurs, and thus bid up gold stocks.


The inverted Dollar chart can give us a different perspective on the Dollar. Remember to think opposite with this chart: In other words, up is actually down and vice versa. Therefore, as you can see, the US Dollar will remain in a bear market as long as the uptrend line remains intact.

A top in the US Dollar will likely occur somewhere near the uptrend line.


Gold Stocks:

Gold stocks have had a strong correction since late November after the 50 MA support was broken. However, the good news is that gold stocks are finally beginning to out perform relative to the metal. Also take note of the positive divergence which is currently brewing in the MACD. This positive divergence suggests that the ratio will soon begin an uptrend.  In other words, gold stocks are beginning to look interesting and long term traders could start to 'scale in' small positions at anytime.

Because I have so many gold stocks listed on my gold section, here are some interesting gold stocks that I'm watching to cut down the list

RANGY, WHT, GG, DEZ, NEM, DROOY, GFI, HMY, PDG, AUY, CDE, AU

Anyway, what typically occurs with gold stocks is that the larger cap ones rally first, followed by the mid tier, and finally the small speculative ones.


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Let's take a look at the gold indexes:

This first chart is of the weekly HUI Gold Bugs Index:

This chart is very intriguing to me: Notice that major rallies off the multi-year uptrend line have occurred whenever the weekly stochastics have been oversold - which is currently the case. If this trend continues, the HUI will bounce near the uptrend line once again, which seems to be at about $195.

The HUI is also forming what looks like a large symmetrical triangle. I expect what will likely occur is that the HUI will rally off this uptrend line, and then bounce around inside this triangle a couple of times before finally breaking out to the upside probably sometime this summer. This triangle measures out to the high $300s or even the low $400s. Therefore, I obviously plan to take full advantage of this bullish setup.


If all goes according to plan and we can invest in gold stocks near the lows, then we should have a very profitable year and our accounts will flourish.

Just a few things to note: Buying on pullbacks is hard to do and opposite of what the name 'Breakpointtrades' implies. There are also a lot of day traders on this website and I also day trade and do very well at it. However, it is also nice to have an investment in stocks that you can hold for weeks or months at a time and simply let them run. In reality, the big money is made in this way, by investing near the lows and riding a trend up for weeks or months at a time.

One can make great money day trading, but it is very hard work, similar to a 40 hour week job. Getting that 0.10 - 0.20 cents here and there is hard work and it's tough to leave the computer even to eat lunch sometimes. The reason I'm excited about gold stocks is because if we can get in near the lows, then we can make as much or more than day trading, but without all the work.

To give you an example, in July 2003, the HUI broke out of a multi year ascending triangle (which is the second triangle you see below). I invested heavily into gold stocks when this occurred and held them until December to January. During this time, I nearly tripled my account and I was up thousands a day for weeks at a time. There is a potential that this will occur once again.

However, this time I am trying to play it differently: The last time, I made my investment when gold stocks broke out to new highs in July. This worked very well, however I would have made more money buying near the low when gold stocks rallied off the uptrend line in April, noted by the green arrow.

This time I plan to make an INITIAL investment near the uptrend line instead of waiting for the triangle to breakout. Notice how I stressed the word initial. In other words, I am not going all out here, but will make an initial purchase that I am comfortable holding longer term. I think there is a good chance that the HUI will bounce off this uptrend line, but then fall back to retest it one more time after an initial rally later this spring. A breakout from the triangle will not likely occur for another 4 to 6 months, during which time I can add to my initial gold positions.

If you decide to play these gold stocks, you also have to decide your strategy and what you are comfortable holding.

The HUI on a 60 min chart is starting to show positive divergence:


The yearly chart shows us that the HUI is at support levels near the 200 level.

However, notice that the HUI has retraced almost exactly 68% of the rally which began in late July! Along with oversold stochastics, this seems like a logical place for it to bounce:


2. General Market Comments:

The markets as well as all government offices will be closed on Monday in observance of Martin Luther King Day. On Tuesday, the only release of the day will be the New York Fed's index on the region's manufacturing sector.

In December, the index came in at a five month high of 29.93, up from November's 18.86. An reading above 0.0 indicates a general expansion of activity relative to the preceding month and December's reading represented a twentieth consecutive expansion. Another growth indicator is anticipated for January but estimates call for a slightly less forceful reading of 27.0.

On Wednesday, the Consumer Price Index (CPI), a key gauge of inflation at the retail level, will be released. The index has experienced a number of oil-related spikes over the last year but since oil prices declined in December, the CPI is expected to show just a slight gain of about 0.1% or 0.2%. And no significant inflation pressures are expected to show up in the so-called core reading, which excludes the volatile categories of food and energy. It is expected to have risen by an in-trend 0.2%.

Also out on Wednesday morning will be the report on housing starts for last month. In November's report, the Commerce Department said that the seasonally adjusted, annualized pace of housing starts fell by 13.1% to 1.771 million. The decline was the largest in almost ten years and the sales pace was the lowest in eighteen months. Economists are looking for a partial rebound of about 5.0% which would translate into a 1.860 million pace.

On Wednesday afternoon, the Federal Reserve will release the latest edition of its Beige Book, an anecdotal summary of economic conditions in the twelve Fed regions. The summary is used as one of the background resources in the deliberations of the Federal Open Market Committee, the monetary policy arm of the Fed. The Beige Book usually has little impact on the markets since it covers information that has already been released in other reports. But the tone may provide some additional insight regarding how the committee is likely to assess the state of the economy and, therefore, how it will frame its policy positions. The next policy meeting of the FOMC takes place on the 1st and 2nd of February.

On Thursday, the jobless claims report will bring the employment issue back into the spotlight. Yesterday's report surprised observers who were expecting a decline in last week's level of initial claims for unemployment benefits after a large increase the week before. Instead, the level rose again to 367,000, its highest reading in fifteen weeks. Once again, analysts are looking for a move lower on the assumption that the data series is working through some volatility associated with the holiday season.

On Friday, the only release of the day will be the preliminary read on consumer sentiment for the month from the University of Michigan. The final Consumer Sentiment Index for December was 97.1, up from November's 92.8 and the highest reading in eleven months. Analysts predict that consumer optimism has continued to rise on additional progress in the employment situation. But the increase is expected to be mild with forecasts ranging from 97.5 to 98.0.

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The market is currently in the midst of earning warnings season and stocks seem priced to perfection. In other words, unless companies at least meet or beat their earnings and offer bullish guidance, they will likely take a hit.

The market looks like it could bounce in the short term, as the 60 min index charts have positive divergence, however I still think the market has probably entered a correction that will last for until spring time.


I posted the following chart the last couple of weeks. It shows how the Market typically performs on a post election year. It should come as now surprise that the post election year is statically weaker than normal as the President no longer has to worry about getting re elected. The following chart from www.chartoftheday.com shows this perfectly. Notice that the market historically performs below average following an election year: Will 2005 act the same? Well just have to see...

Also the chart below which shows us that the Market is historically 'choppy' during January, but then enters a strong correction which lasts form late January until March or April. I would not be surprised at all if this occurs once again.


Let's look a look at the charts:

1st the 60 min charts:

As I stated above, the market looks like it may try to bounce here in the short term. The major index charts are showing positive divergence on their 60 min. charts via the MACD and are near support levels.

For example, the Nasdaq has a strong support level near 2050 and positive divergence to boot. A rally near these lows seems likely


The same for the DOW 60 min chart, positive divergence and support just below:


Daily charts:

As you can see, the Nasdaq has retraced and is near a support level near 2055. A rally off this support level seems logical.


Likewise, the DOW has fallen to a support level and a rally off these lows seems to be in the cards.


Same thing for the S&P 500, strong support just below and a rally near this level seems logical.


Same deal for the Russel 3000 index:


Next, let's take a look at long term charts to give us a 'big picture' perspective.


As you can see, the S&P 500 has strong support at the uptrend line which began in March 2003. We have to assume this cyclical bull market is intact as long as the uptrend line is held.


The same could be said for the Nasdaq, it remains bullish as long as the uptrend line remains intact.


However, this Elliot Wave chart concerns me somewhat: Notice that the Nasdaq has been in an Elliot 5 Wave cycle since October 2002. However, wave 5 of this pattern has probably ended or will end this month. After a 5 wave bullish pattern cycle, generally a downtrend bearish cycle begins which consists of either another 5 wave pattern or an ABC correction.

If this is the case, then it would seem that the market has essentially topped out.

However, I am not all the versed in Elliot Wave theory, therefore I could be totally off base here. Therefore if you have comments or consider yourself to be well versed at Elliot Wave, send me an email to discuss your conclusions.

matt@breakpointtrades.net


Miscellaneous:

Crude oil is once again on the rise and appears to have broken out of a possible bullish W bottom. Either way, could run to the next resistance levels at about $50 and $55 respective This is not bullish for the market.

Also, I have noticed that oil stocks are beginning to perform well. You might want to take a look at stocks in this sector:


As you can see, the CRB commodities index is at an uptrend line and will either rally off this support line or crash through it. If crude oil continues to rally, then the CRB will rally as well.


As expected, the utilities EFT, symbol XLU, is trying to rally off an uptrend line and has formed what appears to be an ascending triangle.


Interest Rates:

The charts show us that a big move in long term interest rates is about to occur, probably to the upside:

As you can see, a symmetrical triangle has formed in the 10 year interest rate chart. A big move will occur in the direction this chart breaks.


5 year rates also show that a triangle is forming, big move coming:


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