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Five Times Out of Five,
Stocks Collapsed After Doing This…
Graham Summers
August 10, 2009
Stocks are overbought.

And by overbought, I mean WAY overbought.

The relative strength index (RSI) is a metric used to measure the velocity and momentum of a given investment by comparing its upward and downward moves from close-to-close. If an investment is moving up strongly, its RSI is higher. Similarly, if an RSI is low, it means the investment is performing weakly.

Historically, RSI's of 70 or higher mean an investment is overbought while an RSI of 30 means an investment is oversold. In these situations the market is primed for a "revert to the mean" trade, meaning you could see a quick correction or turnaround rally as the market snaps back to a more reasonably RSI.

Well, have a look at the NASDAQ today.

As you can see, the NASDAQ recently hit an RSI of 75. This is the highest reading we've seen in nearly two years. In fact, the last time the NASDAQ had an RSI of 75 was October 10, 2007, right before stocks entered their first major leg down in the Financial Crisis, losing 55% in six months.

As soon as I noticed this, I called up Ron Coby, a brilliant portfolio manager based in Medford, Oregon. Ron's one of the smartest guys I know and when it comes to trading short-term moves, he's one of the best in the business. What he had to say completely blew me away.

Ron said, "Graham, you won't believe this, but I went back on the NASDAQ and made a note of every time it hit an RSI of 75. EVERY TIME, the market collapsed soon after. And I don't mean a "plain vanilla" correction, I mean a full blown CRASH."

Ron then forwarded me the following chart. Suffice to say, I was floored.

As you can see, the NASDAQ has hit an RSI of 75 or higher five times in the last 12 years. Every time, the market collapsed soon after with an average drop of -22%. In several cases, stocks suffered a full-blown CRASH.

This is a very serious warning for the Bulls. A high RSI doesn't mean that stocks have to CRASH immediately. But it does indicate that the NASDAQ is more than ready for a serious correction. Again, an RSI of 75 or higher has only been hit FIVE times in the last 12 years. Two of those times were at massive historic bubble peaks. The others were all periods in which stocks were simply far too overbought. And ALL FIVE OF THEM PRECEDED SERIOUS CORRECTIONS.

Be forewarned, if stocks are this overbought, we're in dangerous territory. If smart money like Ron Coby is worried and shifting to a defensive stance, I'm paying attention.

So what sectors do I favor right now? Gold.

As I'm sure you're aware, starting in July 2007, the financial markets entered one of the most severe crises in history. In response to this, the Feds (Federal Reserve, Treasury Department, etc.) have tried to prop up the financial system with numerous interventions. A brief recap of their moves are as follows:

  • The Federal Reserve cutting interest rates from 5.25-0.25% (Sept '07-today)
  • The Bear Stearns deal/ Fed taking on $30 billion in junk mortgages (March '08)
  • The Fed opens up various lending windows to investment banks (March '08)
  • The SEC proposes banning short-selling on financial stocks (July '08)
  • Hank Paulson gets a blank check for Fannie/Freddie but promises not to use it (July '08)
  • Hank Paulson uses the blank check with Fannie/ Freddie spending $400 billion in the process (Sept '08).
  • The Fed takes over insurance company AIG (Sept '08) for $85 billion.
  • The Fed doles out $25 billion for the auto makers (Sept '08)
  • The Feds kick off the $700 billion Troubled Assets Relief Program (TARP) with the Government taking stakes in private banks (Oct '08)
  • The Fed offers to buy commercial paper (non-bank debt) from non-financial firms (Oct '08)
  • The Fed offers $540 billion to backstop money market funds (Oct '08)
  • The Feds agree to back up to $280 billion of Citigroup's liabilities (Oct '08).
  • $40 billion more to AIG (Nov '08)
  • Feds agree to back up $140 billion of Bank of America's liabilities (Jan '09)
  • Obama's $787 Billion Stimulus (Jan '09)
  • Cash for Clunks I & II (July-August '09)

And that's a BRIEF recap.

All of these moves fall under one basic category: loose money. And of course, it was loose money (easy access to credit) that got us into this mess in the first place.

Former Fed Chairman, Alan Greenspan kept the printing presses rolling and interest rates below the rate of inflation, resulting in one of the largest debt bubbles in history. His successor, Ben Bernanke, is not trying to fix that debt bubble by issuing more debt. All he's doing is cooking up an inflationary holocaust that will erase 401ks, savings, IRAs and the like.

It may not be in the next month, or even the next year. But at some point the dollar will roll over and collapse to record lows. When it does, gold will erupt higher.

After all, gold, was, is, and always will be the ultimate catastrophe insurance. With the dollar hitting new lows for the year and the Feds printing money 24/7, gold is set to soar in the coming months.

The gold chart is certainly broadcasting the makings of a VERY large move in the near future.

As you can see, gold has formed a long-term inverse head and shoulders formation (two smaller collapses book-ending a major collapse). Typically a head and shoulders predicts a massive collapse. However, when the head and shoulders is inverse, as is the case for gold today, this typically predicts a MAJOR leg up.

Indeed, any move above the "neckline" of 1,000 would forecast a MAJOR move up to $1,300 or so. Going by history, this is precisely the move we should expect: remember based on historical trends (the gold bull market of the '70s) gold should begin its second and largest leg up in September or October 2009.

Watch the gold chart closely over the next month or so. If gold makes a move above $980 perhaps add to your current positions. If it clears $1,000, hold on tight, because the next leg up in this secular bull market has begun.

I've put together a FREE Special Report detailing an unusual means of playing the gold explosion. While most investors blindly pile into the gold ETF or buy gold bullion, this backdoor play allows you to buy the precious metal at an incredible $188 an ounce. If gold breaks above $1,000, the opportunity for triple digits gains is huge.


Swing by www.gainspainscapital.com/gold.html to pick up your FREE copy!!

Good Investing!

Graham Summers


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