The SPX Will Tank And Gold Will Rise!

Wednesday, October 12, 2016

October is an important month for the US stock market seeing as the SPX has delivered an average of 1.9% returns during the month. This month also happens to keep the investors on edge with the most number of 1% moves in the index since 2000 as shown on the table below.

Considering the historical data, you are in for a surprise if you plan to go long the index. This is because the current fundamentals do not support a rally in October.

Why The US Markets Will Fall From Their Current Levels

High Valuations And Poor Results

David Kostin, the Chief US Equity Strategist at Goldman Sachs, points out that “stock valuations remain extended. The SPX trades at the 84th percentile of historical valuation, while the median stock is at the 98th percentile,” reports Business Insider.

Companies start reporting their third-quarter results during October. Analysts forecast the profits of the SPX companies to drop 1.5%, which would be the sixth consecutive quarterly fall. High valuation, along with poor results, are a recipe for correction to occur.

Impact Of The US Presidential Elections

The 2016 US Presidential election is more important now than ever before. The world will look towards the newly elected President to steer our nation and the world through geopolitical issues, fears of another financial crisis, and expectations of a better and more prosperous future.

After listening to the views of both of the Presidential candidates, the markets believe that if  Donald J. Trump wins, the stocks are likely to tank 10 to 12 % in value. With both of the candidates having their own individual weak points, the elections can swing in either direction. Therefore, it is difficult to predict who will emerge as the final victor of the Presidency.

Under such circumstances, it is unlikely that the Fund Managers will be willing to commit money at higher levels.

Other Risks Involved

The crash of the British pound over the last few trading sessions indicates the damage that can be caused by ‘Brexit’. Deutsche Bank almost certainly will default. Consequently, when it does, it will have ugly consequences for the European banking system.  After Deutsche Bank, investors will target the Italian banks, which are also facing a financial crisis of their own.

Geopolitical tensions with proxy wars between the larger and more powerful nations, as well as fear of increased frequency of future terrorist attacks are all added risks facing any rise in the stock markets.

What Does The SPX Chart Forecast?

The chart below of the SPX shows a lack of conviction by the Bulls. Although the Bulls have not allowed the index to drop below the 2119 levels, they also have not managed to push the index to new highs since mid-August of 2016.

As a result, the index is trading within an equilateral triangle as shown in the charts. The volatility in the index is high, however, the range is getting narrower. This is a sign of an imminent breakout or breakdown from the current levels.

Due to the reasons mentioned, I believe that the break will occur on the lower side. The breakdown is most likely to take the index towards the lower target of 2000 to 2030. The lower targets will open up once the index starts trading below 2119. If the markets again defy gravity, and subsequently rally to new all-time highs, the lower targets are invalidated. A break above new highs will take the index towards the 2250 to 2270 levels.

Gold Is On Sale!

While the above-mentioned reasons are bearish for the stock markets, the same reasons are bullish for the safe havens, i.e. gold, silver and gold stocks.

But isn’t the gold market tanking?

Yes, currently, gold is in a correction, which has been brought about by the expectations of a rate hike by the Fed. 65.1% of the market participants believe that the Fed will hike rates in December’s 2016, according to the CME’s FedWatch tool.

Notwithstanding, the Fed, which started the year off with an expectation of four rate hikes in 2016, will end up with none. All along, they have been ‘jawboning’ the dollar, without which the dollar would have tanked.

The market participants fear that the Fed and the other Central Banks have run out of options and are no longer in control of their respective economies.

Central Banks Have Been Buying Gold

The Central Banks have been net buyers of gold every year since 2008.  Together, they have bought a whopping 2,800 tons, which is an addition of 9.4% to their reserves, according to the Official Monetary and Financial Institutions Forum (OMFIF).

“This is the longest protracted spell of gold accruals since 1950-65, when Central Banks and treasuries acquired a net total of more than 7,000 tonnes during the economic recovery after the second world war,” said David Marsh, the director of OMFIF, reports The Guardian.

“The second quarter of this year saw a 15% increase in gold demand, due to large purchases by the central banks and gold ETFs”, according to the World Gold Council.

The current drop in gold is a great buying opportunity.

The chart of gold shows that the current fall is for the formation of a higher low, which will not be revisited again.  As seen in the charts, gold is already in an uptrend - and the current fall will form a higher low, close to the 1240/oz levels.

The next rise will form a higher high, which will take gold above the current resistance levels of 1377/oz to $1460.

$1200/oz is a strong support level, which is unlikely to be breached. Hence, investors have an opportunity to buy gold with a $50 risk, an equivalent gain of more than $150 in the short-term. That is a healthy 1:3, risk-reward ratio.

Conclusion

The stock market will form a short-term top and offer a 100 point profit opportunity on the short side. During the same period, gold will form a long-term bottom…thus offering a $150 profit opportunity.

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Chris Vermeulen has been involved in the markets since 1997 and is the founder of Technical Traders Ltd. He is an internationally recognized technical analyst, trader, and is the author of the book: 7 Steps to Win With Logic

Through years of research, trading and helping individual traders around the world. He learned that many traders have great trading ideas, but they lack one thing, they struggle to execute trades in a systematic way for consistent results. Chris helps educate traders with a three-hour video course that can change your trading results for the better.

His mission is to help his clients boost their trading performance while reducing market exposure and portfolio volatility.

He is a regular speaker on HoweStreet.com, and the FinancialSurvivorNetwork radio shows. Chris was also featured on the cover of AmalgaTrader Magazine, and contributes articles to several financial hubs like MoneyShow.com.