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CDNX and Gold

It was a volatile week for the CDNX which shed 213 points or 9.4% over Monday and part of Tuesday and then gained 9.3% from the Tuesday low of 2054 to close the week at 2254, a loss of only 23 points from the previous Friday.   This article should bring clarity to any confusion investors are grappling with at the moment.

Our current bearish stance with regard to the CDNX has not changed and we continue to expect this market to sell-off to the 1900 level and perhaps a little lower in the coming weeks.  We view the near-term risk in this market as unacceptably high, so it’s a good time to be holding cash to take full advantage of the opportunities that we believe could soon be abundantly available.  Having said that, technicals and fundamentals confirm to us that the overall bull market remains completely intact.  So any significant additional weakness, if it occurs over the near-term as we believe it will, should be followed at some point by a fresh wave to the upside that ultimately will drive the CDNX decisively through strong resistance at the March 7 high of 2465.

At BMR, our niche is analyzing the CDNX and Gold markets as well as presenting possible individual company opportunities that investors can perform their own due diligence on.  Each investor has to develop their own investment strategy in accordance with their personal financial situation and their tolerance for risk.  Just because we see a high potential for a significant drop in the CDNX over the short term doesn’t of course necessarily mean this will play out, as good as our track record has been, or that you should be dumping everything you own.  But we strongly believe, based on the weakening technical condition of the CDNX and the overall negative geopolitical backdrop, that now is a time to be very cautious with the markets.  In the extremely speculative CDNX, ruled by greed and fear, it’s critical for an investor to always be aware of risks and maintain a proper balance between aggressively trying to grow capital and protecting it.  Patience and nerves of steel are also important – there will come a point when the fear level will spike and that’s when savvy traders and investors will swoop in to make potential fortunes.  Every major CDNX correction, including the most recent one that ended early last July, has presented investors with a golden opportunity to make boatloads of money.  Timing, as they say, is everything.

We’re going to go into detail on the CDNX and explain why we view the rally since Tuesday as a market “trap”.  First, the action in the CDNX since early this month appears to be a textbook pattern as John outlines below – a three-wave “A-B-C correction”:

As John points out in the above chart, CDNX volume Wednesday, Thursday and Friday was simply too weak to sustain this rally.  Yes, the market got back above 2200 which impressed some of our readers but it still faces stiff overhead resistance at a time when the 10 and 20-day moving averages (SMA’s) are in sharp decline.  The CDNX dropped below its important 50-day SMA March 10, a technical event that over the years has consistently preceded major corrections of 20% or more.  What’s worse, the 50-day (currently at about 2315 and just below the 20-day) then started to go into decline and has now temporarily flattened out after the strong gains Thursday and Friday.  Unless the CDNX continues to march significantly higher early this coming week (very unlikely), the 50-day is about to resume its downward trend which will put additional pressure on this market.

The CDNX has consistently proven to be an extremely reliable leading indicator.  What we find very revealing is that after leading all markets higher in the third and fourth quarters last year, the Venture Exchange is now leading markets lower.  So far in March, the CDNX has declined 6%.  The TSX has fallen 2.5%, the TSX Gold Index is down 4%, the Dow is off 3% while the Nasdaq has dropped 4.9%.  Gold is essentially flat for the month.  This kind of under-performance by the CDNX is a very bearish sign and suggests to us that there is trouble on the horizon for the broader markets.

Investors who are encouraged by the CDNX’s 9.3% advance and “turnaround” since last Tuesday only have to read this paragraph for a strong dose of reality.  Market traps can be deadly to your portfolio.  Just one example is how investors got caught in one of these traps in May-June, 2006.   In just six sessions the CDNX plunged 19.6%.  The market then quickly gained 9% or 230 points (just like now and on low volume) and the feeling among some was that the correction had ended.  And then bang – over the next 11 sessions the CDNX fell another 19% which is when the market finally hit bottom.

So let’s quickly recap in point form why we are so concerned about the CDNX at the moment:

1. The market has clearly met powerful resistance between 2438 (the Feb. 22 high) and 2465 (the March 7 high).  Now there is new resistance from the current level through to the 20 and 50-day moving averages just above 2300;
2. Exhaustion appears to have set in – the CDNX climbed 83.5% over the last eight months.  Buying pressure was at a level (“pivot point”) where other pullbacks have started;
3. The CDNX is now significantly under-performing the major markets.  Given the fact the CDNX is such a reliable leading indicator, this suggests to us that the broad markets are about to go into a major reversal which will obviously negatively impact the CDNX;
4. The CDNX fell below its 50-day SMA last Monday for the first time since the start of the big run last summer.  In almost all cases over the last decade, with the notable exception of 2009, a drop below the 50-day SMA following a significant uptrend has preceded a major correction;
5. The CDNX’s 50-day SMA started to decline last Monday, a very negative sign;
6. The 10 and 20-day moving averages continue to decline and are providing additional resistance;
7. Volume on the rally the last few days has been low;
8. A three-wave, A-B-C correction appears to have formed on the charts;
9. The current market pattern is very similar to that witnessed in May-June, 2006, when the CDNX fell nearly 30%;
10. Too many individual stocks have broken down on the charts;
11. The fact the CDNX would experience major technical weakness at a time when Gold is hovering around all-time highs, and commodities in general have been very strong, is a serious negative development;
12. The geopolitical backdrop increases the risk – major confusion and uncertainty on the world stage quickly chase investors away from the world’s most speculative market, the CDNX.
    

Fundamental factors could quite possibly create a very difficult environment for stocks over the coming  days and weeks.  Tonight, an international coalition, eight years to the day the Iraq war started, launched air strikes against Libya as Operation Odyssey Dawn commenced.  The goals make sense – protection of innocent Libyan citizens and the removal of Gadhafi’s evil regime, but there are risks nonetheless.   The United Nations has written a blank check for everything short of an armed ground occupation.  Continued unrest and uncertainty in the Middle East, the potential of rising oil prices due to this unrest as well as demand/supply dynamics, debt problems from Europe to the United States, U.S. budgetary battles, inflation concerns throughout the world, and now the devastation in parts of Japan from the recent massive earthquake and tsunami, plus the affects of the nuclear emergency, are all factors that could negatively impact the markets going forward.  Our thoughts and prayers are with our friends in Japan.  The Japanese have proven to be very resilient and their nation will recover.  But the damage to the world’s third largest economy, which accounts for 6% of global GDP, is likely worse than has been estimated.  Japan is back in recession.  The historic 9.0 earthquake shifted the axis of the earth, could lead to violent volcanic activity in Japan and will have global economic ramifications.  It was truly a “Black Swan” event.

In Canada there is a growing possibility of a federal election which introduces more uncertainty for Canadian investors.  Canadian markets have performed very poorly in three of the last four federal elections.

Gold rallied Friday to finish unchanged on the week at $1,420 while Silver, despite a strong move Friday, fell 62 cents last week to close at $35.28.

The fundamental case for Gold remains incredibly strong – currency instability and an overall lack of confidence in fiat currencies, an extended period of negative real interest rates (inflation is greater than the nominal interest rate, even in China and India despite increasing rates there), massive government debt from the United States to Europe, central bank buying, flat mine supply, physical demand, investment demand, emerging market growth, geopolitical unrest and conflicts (with the volatile Middle East being the focus right now), rising oil prices…the list goes on.  It’s hard to imagine Gold not performing well in this environment.  However, it’s possible Gold could suffer temporarily if a “flight to cash” scenario were to unfold in the markets with assets being sold across the board.

Despite signs of an improving U.S. economy, the Fed is expected to error on the side of caution and maintain its accommodative monetary policy for an extended period which is bullish for precious metals and commodities in general.  The Fed will want to see payroll gains in excess of 200,000 for at least six to nine months and a significant decline in unemployment before withdrawing its massive monetary support (QW2).  The current U.S. economic expansion is just 20 months old (expansions since WW2 have tended to be at least 60 months) and there are still significant risks to the economy including troubling high levels of debt at every level of government, a housing market that is still very weak (one in four mortgages are underwater and prices continue to decline in many areas) and now an increase in oil prices which has the potential of hitting consumers hard.  Interest rate increases in the U.S. appear to be out of the question until at least sometime next year.  Overall, this is the type of environment that’s very supportive of Gold and a speculative commodity-driven market such as the CDNX which is why we see any pullback in the CDNX, minor or major, as merely a correction within a powerful ongoing bull phase.  Any hint of a global economic slowdown, due to a combination of factors, may convince the Fed to launch QE3 after QE2 expires in June.