MERCK PLUNGE WEIGHS ON BLUE CHIPS WHILE SMALL CAPS AND TECHS CLOSE HIGHER -- GOLD HITS 6-MONTH HIGH -- MATERIALS ETF BREAKS OUT
BASIC MATERIALS BREAK OUT... One of the rules I try to follow is to take whatever the market is giving. What I mean by that is there's usually at least one sector in the market that is doing especially well and that offers opportunities for profits. Our job is to find that sector and ride along with it. As I've said before, that can be done through a sector mutual fund or an Exchange Traded Fund. Even if someone is a stock picker, the odds of finding a winning stock are much better if you find a winning sector first. That's usually where the strongest stocks are. One of the themes I've repeated several times is that commodities are the hottest asset class (and have been since 2000). Another CRB Index gain today puts it close to a twenty-year high. Precious metals were today's bigget gainers. That's bullish for basic material stocks that are tied to commodities. While everyone was talking about the plunge in Merck today, and the negative impact that was having on the Dow, The Materials Select Sector SPDR broke out to a new 52-week high. So did its relative strength line. That's where the money is being made now. That's why I keep coming back to it. While drug stocks and healthcare were being sold today, traders were buying aluminum, gold, and steel stocks. They even did a little buying of energy, but I think the oil run is about done for now. That's why I think basic materials in general, and gold in particular, are the best plays in the commodity world. Although I like energy longer term, I continue to believe that the group is in need of a rest.
Chart 1
GOLD HITS SIX-MONTH HIGH... While the media keeps talking about oil, gold has quietly achieved a bullish breakout of its own. The yellow metal climbed $5 today to reach the highest level since the spring (Chart 2). That puts bullion on track to challenge its early 2004 peak near $430. As is usually the case, gold stocks broke out before the commodity. The Gold/Silver (XAU) Index broke through its summer high and its 200 day average more than a week ago (Chart 3). The XAU gained another 3% today and was once again the day's top industry group. [Newmont Mining, which is the biggest gold stock in the XAU, was one of today's biggest gainers in the Materials ETF]. One of the factors moving gold higher is continued weakness in the U.S. Dollar. With the dollar under pressure today, the Euro hit a two-month high and is nearing a challenge of its summer high (Chart 4). I believe an upside breakout is imminent. Notice the close correlation between the Euro, gold, and gold stocks since the start of the year. All three peaked at the start of 2004 and bottomed during May. Now all three are moving up together. That means the dollar is weakening which is good for gold and other commodities -- and basic material stocks.
Chart 2
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Chart 4
NASDAQ AND SMALL CAPS RALLY ... I'm not even going to show today's 55 point drop in the Dow because, in my opinion, it was largely meaningless. Merck accounted for the entire Dow drop. The S&P 500 shrugged off earlier losses to close basically unchanged. The real action was in the Nasdaq and smaller size stocks. Chart 5 shows the Nasdaq Composite turning in another price gain on rising volume. Even more impressive were the gains in small and midcap stocks. Charts 6 and 7 show the Russell 2000 Small Cap Index and the S&P Mid Cap trading back over their 200-day moving averages. Their relative strength lines are at new recovery highs versus the large cap S&P 500. That suggests to me improving market breadth. In a rising market, small caps usually move up first. Large caps follow along eventually. [Although in all three sizes, value stocks continue to outperform growth stocks]. The new signs of relative strength in the Nasdaq market are also encouraging.
Chart 5
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Chart 7
CLARIFICATION ... I said yesterday that relative weakness in energy -- and relative strength in technology -- was good if that role reversal continued. Let me elaborate on that. I happen to be bullish on energy long-term and neutral on stocks long-term. I've recently suggested that an October peak in oil and an October bottom in stocks could pave the way for a fourth quarter market rally that could carry into January. If that yearend rally is to materialize, technology is going to have to show some upside leadership. As I also explained recently, however, I believe any new upleg from here will probably be the final phase of the cyclical bull market that started in October 2002. So far, signs of an oil top -- and a technology bottom -- are only tentative. I was just trying to point out that yesterday's drop in oil -- and the bounce in technology -- needed to continue if we're going to have a good yearend rally.
