Breakpoint Trades - Newsletter

January 30th, 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!

The month of January is finally almost over and I'm sure most of you won't be sad to see it go, unless you have been short. January has been a horrible month for the market, especially the Nasdaq which was down 8.7% at its lowest point. Market statistics say that if the market is down for the first week of January and/or the whole month is weak, then the market will struggle for the entire year.

As you can see from the chart below, the first week of January is statistically important for the market. However, this year essentially the whole month of January has been a blood bath.

Members of breakpointtrades were not caught of guard by this pullback: If you are new to this site, then please read my last newsletter from December 2004.

Last Newsletter of December:

Last week there was big merger news as Procter and Gamble bought Gillette, and SBC is attempting to buy AT&T. These mergers are potentially bullish because if major corporations thought stocks were heading much lower, then they would wait to make their purchases.

The Iraqi elections were today and went relatively smoothly. As I write this, the Nasdaq futures are up 11 points. If this holds, the market will likely gap up tomorrow morning.

Here is a table of the major economic news for next week:

Date	ET	Release	For	Consensus	Prior
Jan 31	8:30	Personal Income	Dec	0.40%	0.30%
Jan 31	8:30	Personal Spending	Dec	0.80%	0.20%
Jan 31	10:00	Chicago PMI	Jan	59.8	61.2
Jan 31	10:00	New Home Sales	Dec	1200K	1125K
Feb 01	0:00	Auto Sales	Jan	5.6M	5.9M
Feb 01	0:00	Truck Sales	Dec	8.2M	8.7M
Feb 01	10:00	Construction Spending	Dec	0.50%	-0.40%
Feb 01	10:00	ISM Index	Jan	57.7	57.3
Feb 02	1:15	FOMC policy announcement
Feb 03	8:30	Initial Claims	Jan 29th	-	325K
Feb 03	8:30	Productivity-Prel Q4	4th Q	2.00%	1.80%
Feb 03	10:00	Factory Orders	Dec	0.80%	1.20%
Feb 03	10:00	ISM Services	Jan	61	63.9
Feb 04	8:30	Nonfarm Payrolls	Jan	185K	157K
Feb 04	8:30	Unemployment Rate	Jan	5.40%	5.40%
Feb 04	8:30	Hourly Earnings	Jan	0.20%	0.10%
Feb 04	8:30	Average Workweek	Jan	33.8	33.8
Feb 04	9:45	Mich Sentiment-Rev.	Jan	96.4	95.8

As you can see, from the table above, lot's of potentially market moving new coming out this week. The FOMC meeting is on Wednesday, however that should be a non issue. The FED is going to raise short term interest rates once again buy 0.25%.

However, what is bizarre to me is that even though short term rates are continually being raised, long term rates keep falling, and actually look like they are going to fall further. Take a look at the following chart of the 30 year bond. As you can see, the 30 year bond has formed an ascending triangle that is on the verge of breaking out. Remember, bond prices and long term rates are inversely correlated. Therefore, if the 30 year bond breaks out to the upside and makes new lows, then the 30 year long term rates will subsequently break down to new lows.

Long term rates obviously have a big effect on the real estate market. Therefore, a breakout here would keep the housing/real estate market going strong for now.

Let's take a look at the charts:

The VIX is inversely correlated with the market: i.e. if the VIX falls, the market rallies, and vice versa.

Currently, the VIX is at an uptrend support line: The VIX is at a 'breakpoint' here, either it will rally off this uptrend line which would cause the market pullback to continue, or it will break this support line, which would cause the market to rally. With the futures currently up this evening, it's likely the VIX will break this trend line to the downside which would be bullish.

The next chart is the Semiconductor/Nasdaq ratio: This chart is important because semiconductors must rally for the Nasdaq to recover. This chart is not bullish and shows that semis. are seriously under performing relative to the Nasdaq. If the support is broken below, then the condition may worsen. On the other hand, if the downtrend line can be broken, then the market could recover.

Based on how this chart currently looks, I'd say there is a strong chance it breaks out bullish. If this occurs, start looking at semiconductor charts for potential trades.

Let's take a look at the index charts:

The Nasdaq has pulled back strongly since early January after breaking down through the bearish wedge. The next major support level is the 200 moving average and the 50% Fibonacci #.

However, the Nasdaq is currently oversold, therefore an oversold rally could occur at anytime.

For me to remain bullish on the market for the long term, the Nasdaq MUST HOLD the uptrend line you see below. If this uptrend line is broken, then will probably consider the cyclical bull market that began in March 2003 to be over and 2005 will not be a good year for the market.

The Nasdaq appears to have ended a wave 5 of an Elliot Wave pattern in early January. This means that the primary wave 5 uptrend is now over and a corrective wave has already begun. This new wave will either be a bearish wave 5 down or an ABC correction.

By extending the time frame, we see that the Nasdaq likes to follow 5 wave patterns. If the Nasdaq has truly entered a bearish 5 wave pattern, then the next couple years will be bad for the Nasdaq and market in general.

The S&P 500 is approaching support near 1165, but there is also support at 1145 and the 200 moving average if the S&P fails to find support at 1165. The S&P also resembles a mini head & shoulders pattern.

Again, just like the long term chart of the Nasdaq above, this long term chart of the S&P 500 is very important to the cyclical bull market and for 2005 in general. If the uptrend line is broken, then 2005 could turn out to be a very bad year for the market in general.

The NYSE could potentially fall all the way to major support near 6800 over the next few months! As you can see, the support line near 7000 needs to hold, otherwise the NYSE says hello to 6800.

Russel 3000 is near major support.

XLU is the Utilities ETF - nice bullish ascending triangle:

Obviously, select stocks in the utility sector should be considered as long candidates.

AEP, DUK, EIX look the best.

Gold and Precious Metals Analysis:

The gold chart below is very informative and interesting to me as it contains a lot of information: the 65 week moving average, an uptrend line, ABCD waves and Elliot Wave, and the commercial trader net short positions.

As you can see, gold has strong support near the uptrend line and the 65 week moving average. Also, the commercial traders have been very accurate at predicting tops and bottoms in the gold market. During major tops in the metal, the average net short positions by commercial traders were typically 2 to 3 times higher than during major gold bottoms. Obviously, it is prudent to listen to the commercial traders when playing the gold market.

Current Analysis:

Not much has changed since last week: As of January 28th, the commercial net short position in gold dropped to 100k contracts. This is only a drop of 2k contracts from the week before. Obviously, the commercial traders are expecting another drop in gold. We need to see the commercial net short position drop to between 30k - 60k to signal a convincing bottom in gold metal. The next commercial trader data will be published on February 4th.

***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

Also, this current downwave looks like it is following an Elliot Wave 5 wave correction - I've placed the numbers of each corresponding wave on the chart below: As you can see, gold appears to be in wave 4, if this is correct, then gold will soon enter wave 5 which would probably end with gold falling to near the uptrend line or the 65 week moving average support areas.

A closer look at the Elliot Wave pattern:

Let's take a closer look at the Elliot Wave pattern: First off, I must confess, I am not an expert on Elliot Wave, I just know a few of the basics. Therefore, if I'm totally off base here, please send me an email. I plan to order a few books on Elliot Wave to increase my knowledge.

As you can see from the chart below, gold is currently in wave 4 of a 5 Elliot Wave pattern. This means that gold probably still has one more down leg which would be wave 5, which I have drawn in below. This pattern will be confirmed if the lows of wave 1 and wave 2 (shown in yellow) act as resistance to wave 4 which is about $432 and the lows of wave 3 are broken.

In a 5 wave pattern, the 5th wave is always shorter then wave 3, and typically about the same length as wave 1. This correlates with a price target between $400 and $410.

Notice how this target range correlates nicely with everything else: For example, the 65 week moving average and the uptrend line are in this range. Also, the current net short commercial position is still too high for a gold bottom, and a drop to the $400 - $410 region would probably be sufficient to cause the commercial short position to drop to levels seen at major price bottoms in gold, typically 30k - 50k.

Of course, US Dollar is key to the gold market; 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, as was well as the 200 moving average near 87.

Current Analysis:

As you can see, not much has changed from last week.

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 has only just begun to turn up, and the MACD is just beginning to cross up. Therefore, the 85 level may not 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 early this year. 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 the stocks 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.

Gold Stocks:

Gold stocks have had a strong correction since late November after the 50 MA support was broken.

Currently the good news is that obvious positive divergence is beginning to develop in the MACD, which signals that gold stocks will soon begin to outperform relative to the metal. In other words, the correction in gold stocks is almost over and a strong rally in on the horizon.

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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. Last Friday the HUI rallied strongly off this uptrend line, so far so good, it looks as though the HUI might soon begin a strong sustainable rally that takes it up to the downtrend line of the symmetrical triangle.

The HUI is forming a large symmetrical triangle, and I've drawn in red trend lines to show how I think this chart may play out this year. As you can see, I think the HUI could bounce around inside this triangle a couple times before finally breaking out later this year. Of course, the HUI could also break out of the triangle on the this first rally, we'll just have to see.

Also, I have placed the price relative to gold indicator on this chart. As you can see, another major buy signal will be generated once the downtrend line on this indicator is broken to the upside. The red arrows represent previous major buy and sell signals based on trendline breaks.