HUMAN NATURE NEVER CHANGES

Emotions are in control again. I say again because we are doing the exact same thing we did in `04 as the market put in the top of the second leg in that cyclical bull.

Once something goes up long enough investors lose all fear and start to believe the move will never end. They start to look for reasons why this time will be different. They rationalize why there will be no correction. I saw it in spades last year as oil topped $147 a barrel. We saw it recently in the gold market as investors became convinced gold and mining stocks would not correct this time... even though miners were stretched 42% above the 200 DMA.

Here is a chart of the `04 top in the NDX.

Notice the parabolic move as everyone finally jumps on board. The five day RSI pushing into nosebleed territory. And the index stretched 20.3% above the 200 DMA. It was obvious to all that tech, the leader of the last bull market, was going to lead the economy out of the recession and there was no impending correction anywhere in the foreseeable future, right?

I've got news for you. All markets regress to the mean, all of them! It's like death and taxes. It's one of those things you can bet the farm on.

Ultimately the Nasdaq 100 dropped 17% into the August `04 bottom.

Investors are now back at it again.

Parabolic move? Check!
Oscillators extremely overbought? Check!
Market extremely stretched above the mean? Check!

Human nature never changes.

NYMO

At most cycle tops the McClellan oscillator tends to diverge as breadth deteriorates. If the market can continue to drift higher this week while the NYMO rolls over we will have the divergence that usually accompanies short and intermediate term tops.

Roughly 60% of the time the market does close the last week of the year positive so unless something unexpected happens we should probably continue to drift higher this week.

MAGNETIC PULL OF THE GAP

Gaps are the bread and butter trade of many hedge funds. The reason being most gaps eventually get filled. It's not all that rare to see a gap on an individual stock, as company specific news creates gaps all the time. It is unusual to see a gap on the indexes as it almost always indicates extreme emotional trading by the entire market. These emotional moves almost always get erased once the market calms down.

Even more rare is to see a gap on the weekly chart. It's only happened a few times since the cubes started trading and every single time the gap filled pretty quickly. (One caveat is the very first month of trading in Dec. of 98 the Q's formed a couple of gaps that weren't filled until the bottom of the 02 bear.)

But we are hardly trading in a bubble environment right now in a brand new issue so I'm pretty confident the gap from 7 weeks ago is going to fill.

At 7 weeks this is the longest stretch that a weekly gap on the cubes has gone unfilled. The only other gap that lasted anywhere close to this was in 2001. Also and emotional period as the market was putting in a yearly cycle low. It took four weeks for the market to cool off and bounce back.

Right now bullish enthusiasm is running hot as the market nears the end of the second leg up in this cyclical bull. I'm fairly confident  that the gap will get filled soon.

History suggests this cyclical bull should experience at least a 10% correction to separate the second leg of this bull from the third. When that correction commences we are going to see that weekly gap on the QQQQ chart get filled.

MERRY CHRISTMAS

9 OUT OF 9

As I noted yesterday the tech sector has broken higher out of the recent coil. It appears to be trying to drag the rest of the market with it but I also noted this isn't a particularly positive development. It would have been better if the market had broken down as we would then expect the decline to be brief followed by a much stronger surge higher. Now we are faced with the odds being for this breakout reversing soon followed by a much longer correction.

I'll also note that 9 out of the last 9 years tech has experienced a significant correction during the first quarter, often in January.

The worst corrections have tended to follow after powerful moves in December.

I think the breakout of the coil now puts tech into that camp.

Another warning sign for everyone listening to the media hype tech is found in the point and figure chart.

Whenever an asset puts 20 X's in a row without a correction it's in an extremely overbought condition and subject to a hard reversal.

The cubes now have 19 boxes checked without a correction and heading directly into the seasonally weak 1st quarter.  

This probably isn't the best time to follow the herd.

THE COIL HAS SPRUNG

I've noted before that contrary to popular belief the initial move out of a coil is often a false move usually followed by a much stronger and more durable move in the other direction.

Well it looks like the coil is going to break up this time. It is certainly breaking that direction on the Nasdaq 100.

Option traders have now gone ballistic buying calls. Usually not the best sign for continued strength over the next two months.

The next thing I will point out is the duration of this daily cycle. Today is day 35. The daily cycle rarely lasts much longer than 40 days. In `04 during similar circumstances, namely the topping of the second leg of the cyclical bull, the daily cycle stretched 45 days.

The market then entered a multi month correction that eventually served to separate the second leg of the bull from the third. The Nasdaq initially corrected much harder as it entered the seasonally weak first quarter.

I was hoping the coil would break down and give us a nice clean move before initiating the third leg of the bull. This break higher now lowers the odds of that happening significantly. It now becomes more likely we are going to see an extended complex correction similar to what happened in `04.

We should see some short term follow through to this breakout but as we are on day 35 and very late in the daily cycle, trading this breakout will probably be better suited to day traders or very short term traders as it's unlikely to last very long.

I'll have more in tonight's update.

ONLY ONE LEFT

A true secular bull market should be characterized by expanding volume as more and more investors jump on board. If not expanding at least steady volume. In the next series of charts you can see that the cyclical bull from `02 to `07 followed this pattern.

You can also see in all these charts except the last one that this cyclical bull is not behaving like a true bull market should. In every case volume has been shrinking as the bull progresses. In every case the 60 week exponential moving average of volume has turned down.

None of these are in true secular bull markets and I dare say this cyclical bull is walking on thin ice. I really doubt we will see more than 3 legs up this time and it certainly won't last anywhere near as long as the last cyclical bull. I have my doubts it will even make it past 2010, probably not even past the middle of the year if inflation explodes like I think it will early next year.

There is one and only one secular bull market left. It's the one market where the fundamentals are not only still intact but improving every day as governments around the world try to again produce prosperity with the printing press. I dare say it's never worked in history and it's not going to work this time either.

I'm just baffled by the fact that supposedly intelligent people in governments around the world can't take the time to pick up and read a history book.

I'm dumbfounded that policy makers can't comprehend the fact that the exact same policies they are pursuing now are the ones that caused the implosion of the global financial system and put us into the worst recession since the thirties.

If too much spending and too much debt are what got us into this how can any sane grown up think that more spending and more debt are going to get us out? Albert Einstein said the definition of insanity is doing the same thing over and over expecting to get a different result. I guess by that definition the Fed must be insane.

We are pursuing the same policies that Roosevelt followed in the 30's that turned what should have been just a nasty 2-3 year recession into the Great Depression. If we don't stop and change course quickly we are going to get the same result he did and the same result Japan did when they went down this path.

We've already lost one decade in the stock market do we really want to lose another or two or three?

Oh by the way, here is the only remaining secular bull market.

STILL WAITING

I thought this was an interesting comparison. The last cyclical bull managed to reach the 50% retracement before falling into a mild corrective phase.

The S&P has now tagged the 50% retracement and despite extremely bullish seasonality and very positive economic and employment news it's been unable to push through this level. Smart money knows it's way too late in this rally to press the long side any longer. That's why we continue to see negative money flows and why the distribution days are really starting to pile up. Big money is stepping aside for the time being and the emotion driven retail trader just doesn't have enough firepower to push this market appreciably higher.

I know it's taking it's time but the correction will come just like it did in `04. I'm expecting the correction this time to unfold much quicker than it did during the last bull. Actually that multi month decline in `04 was the longest 2nd leg correction of all 7 bull markets spawned in the depths of history's most devastating bear markets.

Everything is moving much quicker this time, both bear and bull phases. I'm hoping the correction following this second leg will continue the pattern of rapid moves. Ideally I'd like to see something in the neighborhood of -10% to -14% in 3-4 weeks instead of 6 months.

A sharp violent correction like that would be just what the doctor ordered to reset sentiment back to extreme negative levels. And that's what we need to initiate the third leg up in this cyclical bull market.

CAN THE MARKETS AND THE DOLLAR RISE TOGETHER?

In a word no! Not as long as the secular bear market remains in force. Ultimately I don’t believe the market will be able to hold up in the face of a stronger dollar for very long. Temporarily it can certainly do the unexpected. We all know how the market loves to prove everyone wrong. I dare say 99 out of 100 people if asked two weeks ago where the market would be if the dollar rallied back to 77 would not have said over 1100.

But for the last 7 years this relationship has held up when looking at the big picture.

The best the market has been able to do is drift sideways during any major dollar bounce. This big picture correlation will continue to hold up until this secular bear market is over. I don’t see that happening until two things occur. First we need to clean all the excess debt from the system. That certainly hasn’t happened yet. As a matter of fact the nitwits that started this seem hell bent on proving they can cure the world's debt problem by creating oceans of more debt. I dare say the market is going to continue to prove them wrong.


The second thing that needs to happen is the next big world changing technological breakthrough must occur. The last secular bull rose on the back of the personal computer and the internet. The one before that on the electronics revolution and television. I still think the next secular bull will ride a wave of biotech advances that will vastly improve the standard of living for the human race.


Until that technology starts to come online, whatever it is, the only fuel for further market advances is going to have to come from currency debasement. Real productivity is the only thing that is going to lift the markets and the dollar at the same time.


So short term the market can certainly make us all look like fools but the big picture fundamentals have not changed and those fundamentals will eventually start to drag on the markets as the dollar rally continues.

TRADE SMART

So often we as investors get caught up in the daily movements of the market that we forget to step back and look at the big picture.

A great example are the posters who come on the blog repeatedly warning that the market is going to rally, get on now or risk missing the move, the market never falls in December, blah, blah , blah.

You know what I say? So what! Who cares! Let it rally, but it will do it without me. Why you ask? Well let me start off by showing you what markets don't do.

Markets don't go straight up. When they do they often come straight back down.

Here's is what markets do. They rally for a period of time and then they go through a period of profit taking to cool off.

I've noted on the chart that it's pretty rare that the market will rally for more than 20-23 weeks without a corrective move. This market is on week 22. That means it's getting dangerous to continue pushing the long side. The market is overbought.

Now certainly it can rally further. If it were to make it up to 1156 it would tie the second largest two leg rally in history (1904). But I have to ask what's the point of trying to catch the last few pennies?

Eventually it will correct. It's much safer waiting for the correction and buying the dip than trying to catch the last few percent of the move. If you get caught at the top then you just end up riding the correction down with no dry powder to use at the bottom. I dare say there are probably a few gold bulls that know what I'm talking about?

We already have multiple signs of excess speculation and some evidence the smart money has been exiting in preparation for an imminent correction.

Now I'm not saying one needs to be short, just that now is probably the time you want to do like the smart money and build up cash to use when the correction comes.

Folks there are times when the right move is to just sit and twiddle your thumbs.

Now is one of those times!

THE COIL IN THE S&P

I mentioned the coil on the oil chart a couple of days ago. We have the same thing happening on the weekly chart of the S&P.

As I've discussed before the initial move out of a coil is usually a false move that is soon reversed and followed by a more powerful and durable move in the opposite direction.

Probably the worst thing for the market would be for a break to the upside. That would probably get the bulls all lathered up but if the odds play out, the move would not last and would be followed by a much stronger move down.

The durability of this cyclical bull would be better served if the market would break lower out of this coil as the decline should be short lived although it is often sharp.

We are still awaiting the correction that should follow this second leg up. Historically a move down in the -10% to -14% is expected.

The correction of the first leg in July racked up a -9% decline. Usually the correction of a second leg tends to be a little more severe so I'm guessing we should see at least a 10% correction when it comes.

SILVER TOO CHEAP FOR THE C-WAVE TO BE OVER

At the recent top silver was still too cheap. As a matter of fact it was too cheap for that to be a final top.

At true C wave tops speculative fervor in silver tends to reach a fevered pitch driving the ratio of silver to gold down below 50. At the most recent peak the gold:silver ratio was above 60. Hardly the level of speculation that usually marks a C-wave top.

I expect when this C-wave tops we will see the gold:silver ratio stretch further to the downside than any other C-wave of this entire bull market. I won't be surprised to see sub 40.

At the moment we are still awaiting the end of this correction. I expect it will end when everyone is too scared to buy. We will probably see multiple posters coming on gloating how the bull is dead. How gold was in a bubble and the bubble has burst.

That is the kind of sentiment you see at intermediate term bottoms. And that is the kind of sentiment that will spawn a second leg up in this C-wave that I expect will dwarf anything we've seen up to this point.

THE COIL IN OIL

The weekly volatility coil on the oil chart appears to be breaking downward this week back below the 200 week moving average.

The majority of the time the initial move out of a volatility coil ends up being a false move. The reversal when it comes tends to be more powerful and durable than the initial move.

In this case I'm guessing we get 2-4 weeks of oil moving sharply downward followed by a massive inflationary move higher next year.

It's that move that will again rock the global economy just like it did last year and probably signal the beginning of the end of this cyclical bull market.

TO BUY OR SELL A BREAKOUT

The mining stocks are at an interesting juncture. At yesterdays intraday high they moved to within 3 points of the `08 highs.

Now 10, 20 or 30 years ago buying the breakout would have been a high probability strategy. But the patterns that worked 20 years ago mostly fail nowdays. Why? Because they did work so well in the past. The market eventually discounts anything that works too good.

A few weeks ago I did a post on outdated technical patterns.  Unfortunately many retail traders still trust these old patterns.

Here is what often happens on a break to new highs or new lows.

Often smart money is selling into these breakouts or buying the breakdowns. This is how most major tops and bottoms are made.

Now we are at an interesting junction in the mining stocks. They are on the verge of breaking to new highs. I expect there are a ton of buy stops sitting right above that level as investors await the breakout as a sign that the miners are ready to explode higher.

Do I think the HUI is going to follow the old pattern of breaking to new highs and then just continuing into a runaway move higher? Probably not. It's more likely that we see the familiar pattern emerge of smart money selling into the breakout.

It took gold four attempts before it was able to break above the major $1000 resistance level.

All in all, I doubt buying the initial breakout is going to be a winning strategy. I expect it's going to take at least two attempts for miners to successfully break above this level.

REGRESSION TO THE MEAN WORKS

Gold is now in a runaway move. Unfortunately that is the worst thing that could happen to precious metal investors at this point.

Why? Because just like everything else in the world gold will eventually regress to the mean.  The law of action and reaction says that the further anything is pulled away from the mean the more violent the snapback tends to be when it comes.

You can see in the following chart that gold is now about as overbought on a weekly basis as it has ever gotten. Probably not exactly the best time to get wildly bullish.

Unfortunately rabid bullishness is exactly the emotion brought out in investors when one of these things appears. When we should be extremely fearful we often become euphorically complacent.

The next chart is mining stocks.

At today's intraday high the HUI was stretched 42% above the 200 day moving average. There have only been 4 rallies that have stretched further above the mean.  Each and every one of them underwent a violent correction averaging -22% in a month or less as soon as they topped out.

Again I'll stress that 42% above the mean isn't a sign that happy times are here to stay. 42% above the mean is in fact a sign that one should be "hand in the piranha tank" nervous. The question isn't whether or not you are going to get bit, it's how many fingers are you going to lose.

BITE OUT OF AAPL

AAPL has been by far one of the premier, if not the premier, stock in the market leading tech sector.

However tech is starting to lag. The same thing happened as the market was topping out in early `04.

Yesterday despite the market rallying strongly our premier stock in the leading sector dropped almost 1.5%. That's probably a warning sign in my opinion.

But let me show you what else happened. AAPL marginally broke the uptrend line from the March lows yesterday.

It's a bit hard to see in the expanded chart but here is a close up of the same chart.

I've gone over several of the warning signs that are starting to crop up lately and this is just one more.

GOLD NEEDS TO CORRECT

Let me start off by showing you a longer term weekly chart of gold.

You can see these intermediate term corrections come like clockwork about every 15-25 weeks. Some run a bit long like the cycle that bottomed in Oct. `09 and some are short like the last cycle in July. But whether they end up being long or short they always appear.

The problem right now is that gold has rallied for 21 weeks with no sign of anything that can even remotely be considered an intermediate term correction. Now unless this time is different (it never is) then gold is now due, actually over due, for that correction.

This is why I think it's dangerous to keep pushing the pedal to the metal at this time.

Now let me show you another chart. This one is the mining index.

You can see the HUI has rallied right up to the top of the trend channel that it has been in for the last year. Now if gold was on week 10 of its intermediate cycle I would say the miners are going to break out of that channel. I actually expect them to break out and move into a parabolic rally during the next phase of the C-wave. But 21 weeks into the rally is probably not a good time to bet on that parabolic move.

In order for gold to continue this rally and reach the level that I think it's going to eventually reach ($1500-$1800) we absolutely need to see a scary correction. Gold desperately needs to wash out all the bullish optimism that is so prevelant in the gold sector right now. A scary 3-4 week correction would reset sentiment back to levels of bearishness that could spawn a monster second phase of this C-wave.

More in tonights report.