After an Oversold Bounce, Will Commodity Blues Spread to Stocks?

SAN DIEGO ( - Why do horses wear blinders? Blinders restrict a horse's vision and keep its focus squarely on the race ahead. Investors too are in a race, a race to outperform benchmarks and deliver profits.

To remain focused on the prize, investors/traders need to cut out needless and confusing information and zero in on what drives stocks.

Needless and even misleading information is often spread by Wall Street and the media. As far as media real estate is concerned, the front page of the Wall Street Journal is one of the most coveted spots.

The Silver Lining

After a 175% rally, silver finally made it there on April 27. The headline: 'Silver rush spreads to stock market.' The message: 'Investors have turned to precious metals amid worries about inflation and the weakness in the U.S. dollar. The metals are increasingly considered attractive as a permanent store of value that doesn't diminish like paper currencies.'

$100 invested in the iShares Silver Trust (NYSEArca: SLV) on April 27 would be worth $79 today. $100 invested in the PowerShares DB US Dollar Bullish ETF (NYSEAra: UUP) would be worth $102 today (as of May 9).

This doesn't mean that silver won't be a better long-term store of value than fiat currency. Over the short-term, however, media cheerleading has been distracting.

On April 26, with silver just slightly below 48, the ETF Profit Strategy Newsletter stated: 'The gap up open may have been an exhaustion gap and cautions that a historic reversal may have occurred. As you can see on the chart, silver is close to triggering a percentR low-risk entry. A failed low-risk entry could be immensely bearish.'

The failed low-risk entry (a sell signal) occurred on May 3, at 43.22. On May 5, with silver at 34.7, the ETF Profit Strategy Newsletter recommended to close short silver positions.

The Truth about Oil

The correlation between oil (NYSEArca: USO) and stocks (NYSEArca: VTI) is one of the biggest misconceptions on Wall Street.

The media spoon-feeds the idea of an inverse relationship between the two in which rising oil is bad for stocks and vice versa. This is not the case. Since the March 2009 low, oil prices have tripled while the S&P (NYSEArca: IVV) doubled.

Oil prices topped on March 2 at 114.83 and dropped as low as 94.63 thereafter. This should have been good for stocks, but it wasn't. The S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), and Nasdaq (Nasdaq: ^IXIC) declined hand in hand with oil.

In its outlook for the month of April, the ETF Profit Strategy Newsletter observed on April 6: 'Crude oil seems to have broken out of a triangle. A measured move could take prices up to $115/barrel. In April 2008 oil started the month at 105 and closed the month at 116. Based on the 2008 precedent, the stock market could move higher despite rising oil prices. Once oil pushes to 115 - 122 even Wall Street will realize that energy costs are zapping the consumer and the stock market.'

Oil did reverse exactly at its measured breakout target and at the bottom of the 115 - 122 range. Stocks paralleled oils move and reversed at the lower end of the target range for a market top outlined in the same April 6 forecast. This lower end - 1,369 - is an important Fibonacci projection level and repelled stocks with a vengeance.

Reversal or Rejuvenation?

Both stocks and oil reversed at the lower end of their ideal target range. This begs the question whether the upper end of the target range will be challenged?

Is the bounce since the recent reversal simply a retracement bounce or another springboard for new highs?

Keep it Simple

Sometimes the simplest analysis is the best. As the chart below shows, the S&P is above the previous resistance at 1,339 (now support), above the 20-day moving average and above a trendline established since the March 16 low.

On May 5, when the S&P closed at 1,335 the ETF Profit Strategy Newsletter noted that support has held and advised the following: 'This would be an ideal set up for at least a bounce. Being short equities is not prudent unless the 20-day SMA and low-risk entries are breached.' It was also recommended to exit short silver (NYSEArca: ZSL) and gold (NYSEArca: GLD) positions.

The Challenge Ahead

The challenge now is to balance the market's up side potential with the down side risk. On one hand you have a huge S&P red candle high against the minimum target for a major market top, along with a VIX (Chicago Options: ^VIX) that's back down to below 17.

Investors Intelligence also reported the highest amount of buying climaxes (643) since April 2010 (Buying climaxes take place when a stock makes a 12-month high, but closes the week with a loss. They are a sign of distribution and indicate that stocks are moving from strong hands to weak ones).

On the other hand, you have the S&P above important support and a few bullish signs, the most important of which is higher Fibonacci target and a multi-decade trendline that could act as a magnet for prices.

The challenge for the next couple of weeks will be to balance the potential of a major market top (QE2 cash flow is about to run dry) with the magnetic pull of a higher price target.

The ETF Profit Strategy Newsletter's forecast for the month of May includes the target range for a major market top, crucial support, and the one investment/trading strategy that works regardless of what the market decides to do. The Newsletter provides updates on Sunday evening along with at least one mid-week follow up.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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