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The Bottoming Process is now Underway

Contributed by Olaf Sztaba
NA-Marketletter
www.na-marketletter.com
Nov 14, 2008

Stocks should gravitate toward the 200-week moving average. Volatility is most likely to continue.

In our previous Gold Comment, we described market behaviour as reaching an extreme. On October 10th, the S&P 500 was down 46% from its high, close to the maximum bear market declines of 49.1% in 2002 and 48% in 1974. The S&P/TSX composite lost 42% from its June 2008 high.

The average bear market lasts 13 months - we are now 13 months away from the October 9, 2007 high in the S&P 500. The amount of cash on the sidelines is enough to buy over one-third (35%) of the S&P 500 index or the entire gold sector!

It had been anticipated that gold and the gold sector would ride the current crisis much better than the rest of the market. It didn't happen. Since the March 2008 highs, the XAU and HUI indices declined 68% and 70% respectively.

These historical extremes have indicated a low point in stock prices in the past.

Evidence suggests that during the initial stages of a major crisis, gold and gold stocks usually follow the general market. It is only later on, when the recessionary period is well underway, that gold and gold stocks begin to decouple from the rest of the market (look for more info and a longer-term perspective on the subject in our special report "gold and gold stocks within the 40-year cycle.")

For this reason, gold investors should watch the general market path to recovery because gold and gold stocks should move to the rhythm of the market.

Since the October 27low, the XAU index has had an impressive recovery of 32%. During this period, our indicators have risen from extremely oversold conditions to readings that are more normal.

Although a re-test of the October low may occur, a period of consolidation (such as we have now) would provide a stronger base to support the next advance. This consolidation period should be used to find good trading opportunities.

"The North American markets have reached their historical extremes from which major recovery rallies have previously occurred. gold and gold stocks should track the stock market into the New Year and lead the recovery at a later date." -Olaf Sztaba

While some stocks have fared better than others, the majority of gold stocks have experienced a serious decline, well below their 50- and 200-day moving averages.

The decline created a huge discrepancy between the prices and the 50-and 200-day moving averages, an abnormality that is usually corrected during the subsequent recovery rally.

Not only could the anticipated rally diminish gaps between stock prices and the moving averages, but the up-move should help in evaluating the strength or weakness of the entire sector.

The results of any attempt to overcome the 50-day moving average should provide the first clues. A decisive rally above the 50-day moving average and sustained consolidation above it would be a positive technical development. This would certainly strengthen the indices and help them face a much more important 200-day moving average.

Numerous gold rallies failed in the past because some investors, among them many so-called "gold bugs," got excited about the prospects of the sector too early in the piece. Therefore, it is imperative that the current fragile recovery is played out over a longer period so the stocks have enough time to cement their lows and build basing patterns before a bullish enthusiasm makes its appearance.

Whether the current back-and-forth action will keep the disbelief factor alive is still to be seen.

At the same time, it is important not to become discouraged and sell during periods of weakness. It is to be expected that during the next few weeks, the news will continue to be negative and in some instances, the stock market may react nervously.

During this time, it is crucial to focus on the stocks that have held fast during the recent sell-off and have developed convincing bottom patterns (Alamos Gold or Royal Gold). Other stocks, such as Barrick Gold or Goldcorp, declined toward the lower boundaries of their multi-year trading ranges. Once these stocks have finished cementing their recent lows, they should begin moving toward the upper borders of the trading range.

It is distressful and confusing but this is what the bottoming process looks like. This is the time when the major indices cement their recent lows and begin a slow but steady climb towards their 200-day moving averages.

Unpleasant pullbacks driven by the latest news should not be viewed as the start of another sell-off, but rather as part of a bottoming process.

Look for stocks that have held well during the recent sell-off and have developed convincing bottom patterns.

Nov 10, 2008
Contributed by Olaf Sztaba
email:
osztaba@na-marketletter.com
website:
www.na-marketletter.com

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