BONDS SURGE ON BAILOUT CONCERNS -- LONG-TERM RATES HIT RESISTANCE - GOLD EXTENDS ITS GAINS AND COVERAGE -- USING SHORT-TERM RSI TO IDENTIFY PULLBACKS

BONDS EXTEND ADVANCE... Today's Market Message was written by Arthur Hill. - Editor

As John Murphy noted, there was a flight to safety as money charged into gold, bonds and the Dollar on Tuesday. Bonds and gold added to their gains with another surge early Wednesday. The rise in bonds reflects a lack of confidence in the banking bailout proposed by Geithner and company. Chart 1 shows the iShares 20+Yr T-Bond ETF (TLT) bouncing off its support zone with a big move over the last 2-3 days. First, notice that TLT surged from 92.5 to 122.5 in November-December. This huge move created an overbought situation that needed to be rectified with either a correction or a consolidation. TLT choose the correction route with a rather sharp decline in 2009. However, the decline was not as sharp as the prior advance. The bond ETF found support from broken resistance and the 62% retracement mark (yellow zone) in the low 100s. Also notice that TLT became oversold as RSI touched 30 at the end of January. Even though the trend this year is down as TLT remains within a falling channel, the surge off this support zone is a strong start towards resuming the Nov-Dec advance. The setup below first appeared in the 29-Jan market message.

Chart 1

LONG-TERM RATES DECLINE... The 10-Year Note Yield ($TNX) hit resistance around 3% and declined sharply over the last two days. Remember, bonds and rates are negatively correlated. Bonds move higher as rates move lower and visa versa. After plunging to around 2% in late December, Chart 2 shows the 10-Year Note Yield surging back to 3% this year. In percentage terms, this is a 50% advance within a two month period. Even though still low by historical standards, the sharp rise in treasury rates affects other rates, like mortgage rates. 30-year fixed rate mortgages followed treasury yields with a move above 5% in early February. Further strength in bonds would put downward pressure on long-term rates. This, in turn, would put downward pressure on mortgage rates. While lower rates are generally bullish, falling rates (rising bonds) presents a double-edged sword. A surge in bonds could come at the expense of the stock market because bonds represent a flight to safety.

Chart 2

GOLD LEADS THE WAY IN 2009... The streetTRACKS Gold ETF (GLD) has been a regular feature of the market message in 2009. By my count, gold has been featured in the market message 15 times this year. This is second only to general stock market observations and coverage of the major stock indices. Enough already! Chart 3 shows GLD with four other asset classes: the US Dollar Index Bullish ETF (UUP), the Commodity Tracking Fund (DBC), the S&P 500 ETF (SPY) and the iShares 20+Yr T-Bond ETF (TLT). Only two of the five are in positive territory for 2009. Gold and the Dollar form a strange pairing, but that's where the money went so far this year. Stocks, commodities and bonds are all down for the year. Given the strong Dollar, weakness in commodities is not a surprise. Even though strength in gold is somewhat surprising, it merits our continued attention.

Chart 3

Chart 4 shows weekly prices for the streetTRACKS Gold ETF. GLD broke channel resistance with a surge four weeks ago and remained strong. This channel looks like a big falling flag, which represents a bullish consolidation pattern. The breakout signals a continuation of the prior advance. This targets a move above the 2008 high, which would forge a 52-week high.

Chart 4

Chart 5 shows daily prices for GLD with two RSI variations. GLD is up over 30% from its November lows, but 14-day RSI has yet to become overbought. RSI suggests further room to run before becoming overbought. The second indicator shows 3-period RSI, which is designed to find short-term oversold conditions. Catching a strong uptrend can be challenging. Kind of like hopping on a moving train. In order to generate short-term oversold signals, indicator timeframes need be shortened. A number of traders in the blogosphere have been advocating 2-period RSI to identify short-term overbought/oversold conditions. This example uses 3-period RSI. A move below 30 denotes an oversold condition. A subsequent move back above 50 signals a resumption of the uptrend. Like all indicators, it is not perfect, but can be used to help identify short-term pullbacks within medium-term uptrends.

Chart 5