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Make no
mistake; the four-day rally we just saw was nothing more than short covering
in front of the Fed meeting just in case Bernanke surprised us with QE3. As
expected he confirmed that QE2 would end on schedule. The dollar rallied and
the market sold off on the news.
Folks, I don't think this is over
yet. In the chart below you can see that every intermediate cycle low
exhibits some kind of capitulation volume as market participants
panic.
 
We clearly have not seen any kind of
a selling climax yet. As a matter of fact volume has been running slightly
lower than average. This is not what happens at a true intermediate bottom.
The average duration of an
intermediate cycle is between 20 and 25 weeks. Two of the last three
intermediate cycles bottomed perfectly in that timing band. The March cycle
was slightly shortened by the Japanese tsunami which generated tremendous
bearish sentiment in a very short time.
However there is no serious calamity
that should shorten the current cycle to 13 weeks. One could claim that the
Greek situation is driving the decline, and once it gets resolved the
correction will end. I think that's highly unlikely. The market has known for
over a year that Greece is going to default. There's no surprise there. I
suspect the next Black Swan will come in July as Spain, or Portugal, or Irish
bond yields spike, or something completely out of the blue occurs, like an
implosion of the Australian housing market. It's in times of stress that
flaws in the system break.
Since we don't have any capitulation
volume yet, and it's still too early for the intermediate cycle to have
bottomed, the assumption is that this correction isn't finished.
So far the market is still following
the template I laid out in "The Bear is Back" post. I expected some
kind of counter trend rally to relieve extreme bearish sentiment levels and
oversold conditions. We are getting that rally now (it may have already
ended).
Once the counter trend rally runs its
course the market should have another leg down, bottoming in late July to mid August. At that point I expect Bernanke to freak out
and initiate QE3. That will be the signal for a more durable and probably
explosive rally.
But remember, the most violent
rallies occur in bear markets!
Toby Connor
Gold Scents
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