FINANCIALS LEAD MARKET HIGHER OIL AND GASOLINE BREAK CONSOLIDATION PATTERNS XLE AND OIH FOLLOW ENERGY PRICES HIGHER GOLD CHALLENGES RESISTANCE AGAIN USING RSI TO IDENTIFY PULLBACKS

BANKS SURGE AHEAD OF STRESS TEST... With news leaking out all over the place, financials were sharply higher ahead of Thursday's stress test results. Officially, the results of the stress test are to be announced on Thursday. Unofficially, Bloomberg and other outlets have been reporting preliminary results over the last two days. Either the market likes what it hears or the shorts are running scared. Probably a little of both. Chart 1 shows the Financials SPDR (XLF) breaking consolidation resistance for the second time in six weeks. The next resistance zone resides around 14 from the December highs. Chart 2 shows the Regional Bank HOLDRS (RKH) with similar patterns and resistance coming into play around 80. With resistance levels close at hand for both, the market could be setting up for a buy-the-rumor and sell-the-news scenario. The rumor is the positive results of the stress test. Once the news hits, we could see some selling pressure in the form of profit taking.

Chart 1

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OIL AND GASOLINE RISE... Chart 3 shows the United States Oil Fund (USO) breaking flag resistance last week and moving above 31 this week. Price action was looking bearish when USO gapped below the 50-day moving average, but the ETF immediately firmed and filled the gap with the flag breakout. After the March advance, the flag acts as a corrective pattern. Price action now looks bullish with the next resistance area in the upper 30s. Chart 4 shows the US Gasoline Fund (UGA) also with a consolidation breakout over the last few days.

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RISING OIL FUELS ENERGY ETFS... Chart 5 shows the Energy SPDR (XLE) breaking triangle resistance last week and continuing higher this week. The ETF broke triangle resistance with a surge last Wednesday, but fell back below the triangle breakout with a rather sharp decline last Thursday. Not to be denied, the bulls bounced right back with another move above triangle resistance. Even though a big resistance level around 52.5 is coming into play soon, this breakout has revived the bulls. Also notice that the price relative turned up as XLE outperformed the market over the last 1-2 weeks. Chart 6 shows the Oil Service HOLDRS (OIH) stealing the show within the energy sector. OIH broke resistance at the end of April and continued above 100 this month. If you think SPY is overbought, consider the fact that OIH is up over 50% in the last six weeks.

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GOLD BATTLES RESISTANCE... Chart 7 shows the Gold SPDR (GLD) challenging resistance around 90. First, let's review the setup. GLD surged from November to February and then retraced 50% of this advance with a falling wedge decline. Both the retracement (~50%) and the pattern (wedge) are typical for corrective patterns. GLD surged to resistance from the 50-day moving average and the wedge trendline in late April, but fell back below 87.5 last week. This week's second attempt on resistance is the big test for bullion. A break above 90 would be bullish for GLD and target a move towards the February high.

Chart 7

Believe it or not, there are probably some bullion bears out there. After all, there is a buyer (bull) for every seller (bear). What might the bears see on the chart? First, bullion bears would likely point out the failed surge in mid March (orange area on Chart 8). Second, GLD broke below its March lows with a sharp decline in early April. Even though GLD bounced back over the last few weeks, a small rising wedge or flag is taking shape with support at 86. A break below this level would signal a continuation lower and target further weakness towards the next support level around 79-80. Right now, however, the bulls can take solace that little flag/wedge has yet to be broken.

Chart 8

USING RSI TO IDENTIFY PULLBACKS... Last week I featured the S&P 500 ETF (SPY) with a 3% moving average envelope to define the current uptrend. Based on this indicator, the trend can be considered up as long as SPY holds the lower envelope. While strong trends favor trending following indicators, such as moving averages, there is no need to completely dismiss oscillators. Assuming that this two-month stampede started an uptrend that could last well into the summer, we can use oscillators to identify pullbacks that may offer a second chance to partake in the uptrend. In addition, John Murphy noted yesterday that he would be inclined to wait for a pullback or some consolidation before committing new funds.

RSI IN A STRONG DOWNTREND... First, let's see how RSI worked during the prior decline. Chart 9 shows SPY from August 2007 to March 2009, which encompasses an extended decline. 14-day RSI is shown in the indicator window with a resistance zone between 50 and 60 (yellow area). Notice how RSI became oversold in November 2007 and then registered another four oversold readings. There wasn't a single overbought reading during this decline. This is testament to the strength of the downtrend. Despite a strong downtrend, there were counter trend rallies that pushed RSI back above 50. On four occasions, RSI met resistance in the 50-60 zone (red arrows). There was an overshoot in May when RSI moved above 60. However, RSI did not surpass 70. In a downtrend, the first potential resistance zone for RSI is 50-60.

Chart 9

RSI IN A STRONG UPTREND ... While 50-60 marks RSI resistance in a downtrend, the inverse is true in an uptrend. RSI should move above 70 and become overbought in a strong uptrend. This is a show of strength. Once becoming overbought, traders can then look for a pullback in momentum. Instead of the 50-60 zone acting as resistance, the 40-50 zone now acts as the first potential support area. Chart 10 shows an example of the 40-50 zone acting as support during a rally. After surging in October-November (two months), SPY worked its way higher for the next five months (December to April). A channel unfolded over this period and SPY formed reaction lows soon after RSI moved below 50 (green arrows). Keep this study in mind over the next few weeks.

Chart 10

RSI NEARING OVERBOUGHT LEVELS FOR SPY... Turning to the current chart, SPY is both strong and overbought. The ETF is up around 35% in the last two months and approaching its falling 200-day moving average. In addition, RSI is nearing 70, which is the overbought threshold for this momentum oscillator. Pullbacks since early March have been limited to just two days. Wow. Despite a strong uptrend, this up leg looks closer to its end than its beginning - or even middle. At the very least, it would be prudent to wait for a pullback. The shaded area around 85 shows potential support from broken resistance. The yellow rectangle shows potential support for RSI (40-50). These are the first areas to watch.

Chart 11