Markets appear to have calmed down somewhat, at least for the moment, which makes this lull an excellent time to take a step back and evaluate recent market moves and attempt to suggest whether the sudden recent moves to the upside in financial markets and declines in gold reflect genuine reversals - or whether, in fact, they are simply corrective actions within ongoing trends.

During the 35 years I have been trading, writing and advising clients, I have learned several useful rules and one of the most consistently important is the concept that after sudden and dramatic moves in one direction, markets frequently ‘correct’ those moves by making a one-third to two-thirds moves in the opposite direction.

Perhaps the most famous illustration of this type of move relates to the early days of the Great Depression. The world is well aware that the Dow Industrials plunged from 384 in September 1929 in rapid-fire declines down to about 190 by mid-November 1929, specifically including the days surrounding “Black Tuesday”, October 29, 1929. However, what many people do not realize is that the markets then put on a stunning rally back to above Dow 300 during the next few months, a rally which appeared to suggest that the initial declines were wrong-headed and renewed prosperity was ‘just around the corner’.

However, such optimism was not to be fulfilled and the Dow eventually plunged to a historic low of 41 by mid-1932. Even then, the Dow did not fall south in a straight line, but it was a six-event pattern of decline, recovery, decline to new low, recovery, and so forth until the final bottom was reached.

In terms of long-term bull markets, we frequently see a similar but reverse pattern, namely rally, correct back, rally, correct back, etc.

With that idea in mind, there are two charts which appear to be of particularly timely interest. They are gold and the Dow Industrials. First gold:

Please note the period from mid-March through late April when gold rose from 1,400 to around 1,580 before correcting. Our one-third to two-thirds rule would have suggested a correction to between 1,460 and 1,520 – and that is precisely what took place, with gold falling to about 1,475 before forming a new base and then heading higher.

In the present case, gold has surged, almost without let-up, from 1,480 to near 1,810 – a distance of 330 dollars, suggesting that a correction of that advance would result in a decline to between 1,590 and 1,700. As this is written early morning on the 12th of August, gold has declined to about 1,730 and looks as if it will be headed toward the target range of a ‘normal’ correction.

There are three observations we would offer as guidelines going forward. If this decline aborts and immediately heads higher to break out into new record territory, we believe that would be an indication that gold was in an immensely powerful short term bull trend, suggesting higher – perhaps much higher prices – in the near term. If gold falls into the normal correction range, we would suggest that it will form a new trading base – perhaps such as occurred through May and June – before resuming its long-term bullish trend. However, if gold falls below the bottom of the range near 1,590 and accelerates to the down side on heavy trading value, that would suggest that something of a more serious nature was taking place, perhaps even threatening the long-term golden bull itself.

The Dow Industrials offer us a similar set of observations. In the latest ‘waterfall’ decline, the Dow plunged from 12,700 to about 10,600 – a distance of close to 2,100 points. Accordingly, using our 1/3 to 2/3 rule, a recovery of between 700 and 1,400 points could take place without altering the negative trend. Therefore, a rally back to the range of 11,300 to 12,000 might be anticipated – and that is what has been taking place over the past few days.

We would also suggest that the same guidelines noted above for gold would also apply in the interpretation of near term moves in the Dow.

There is one other ‘technical’ matter to note. Please observe that trading volume in the Dow Industrial stocks surged dramatically when the average was falling but dropped off with incredible rapidity during the recent rally phase. An old ‘saw’ of technical analysis suggests that the valid market move comes in the direction of an increase in volume.

Please remember that technical analysis is only one of many tools in evaluating markets and should NEVER be looked on as infallible. However, we would offer the opinion that technical analysis’ true value lies in suggesting the direction and distance of market moves.

(Mr. Melman is a member in good standing of the Canadian Society of Technical Analysts.)

Unfortunately, publication deadlines for several articles are pressing down hard on us and so, we are forced to cut short our contribution for today, adding only this observation. For the time being at least, the worst of the world’s fears seem to have been set aside, giving markets time to recover some sense of balance. How long this period of relative tranquility will last is anyone’s guess.

As of 8:15 AM PDT, financial markets continue to recover with the Dow Industrials ahead by about 90 points while the TSX Index opened moderately to the upside. Gold and silver are both trading lower with the yellow metal priced near $1,735 and silver holding close to $38.50 per ounce. Base metals are little changed and mining share indexes, reflecting lower precious metals prices, are off by about 1.5 to 2%.

In other markets, long term interest rates have resumed their decline, the US Dollar is slightly lower and the price of crude oil is holding in the mid-80 dollar range per barrel.


All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Monday, August 15, 2011