Market WrapUp (09-09-03)

Financial Sense Online ^ | 9/9/03 | Ike Iossif

[arete]

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Today's WrapUp by Ike Iossif 09.09.2003  Mon   Tue   Wed   Thu   Fri   Archive

"The Meaning of Divergences"

I hear many  talking about "divergences" a subject that is often misunderstood.  Anyone who has ever worked on a project involving the development of any particular indicator is aware of the fact that "not all divergences are created equal!" Normally, a divergence between price and an indicator is a warning sign that price may be soon changing direction. Eighty to ninety percent of all divergences between price and an intermediate or long-term indicator "signal" a potential change in the direction of price. That is the reason most people are aware of only this type of signal that is derived thru divergences, also known as "directional signal."

Divergences signify directional signals, only when the "environment" from which the measurements are taken has remained the same thru-out the time period the indicator is designed to cover. The input values must come from the same type of sample. For example, let's say we are employing a 50 day XYZ indicator and over the past 20 days there has been a significant change in the market environment. That means the input values of the indicator come essentially from two different samples: one that covers the first thirty days, and one that covers the last twenty days. Since the market "has changed" the last twenty days, our indicator is no longer comparing apples to apples. Consequently, there is about to be a distortion, which will appear as a "divergence." That "divergence" will remain in place until all the data from the previous market environment are filtered out and are replaced by data that reflect the current environment, so once again we have a homogenous sample.

If a divergence signifies a "directional signal," then on average, price will conform within a time period less than half the time period the indicator is designed to measure. For example, if a 50 day XYZ indicator starts to diverge today, we should expect price to follow within the next 25 days at most. In the meantime, there should not be much price movement. So, if we observe a divergence, but price remains unaffected—and more importantly it continues to defy the indicator past the half point—then we should begin to suspect that our indicator is giving us a much more important signal. It is giving us an "environmental signal." More likely, there has been a significant change in the market's environment, which accounts for the price's ability to maintain course despite the "divergences." Our indicator's inputs are coming from two different samples, that is why we are getting the divergence!

When a variety of intermediate/long term indicators have been diverging with price, for a period longer than half the duration of the period they are measuring, then we need to consider the possibility that the market is undergoing a "cyclical" or "secular" change. If it is, price will continue to move in its own direction and the indicators will again begin to confirm price, as soon as the data from the previous environment are replaced with all current data.

Usually, if a "cyclical" or "secular" change has taken place, in addition to the price being able to stay the course, we will also observe, initially, all the indicators to diverge. But as time goes on, we will see that shorter-term indicators begin to confirm price; while the longer ones continue to diverge. For example, let's say we use the same indicator for two different time frames, a 30 day XYZ indicator, and a 60 day XYZ indicator. Initially both will diverge from price, but if 30 days later, price has held up, the 30 day XYZ indicator begins to confirm price; while the 60 day is still diverging, then more likely the divergence is due to data distortion, because as soon as 30 days worth of latest data were inputted in the 30 day indicator, it started to confirm price.

Many people who are not familiar with mathematical concepts, look at an indicator that is diverging, and because price is not complying, they think that either the indicator has become useless, or the market is "strange" or "weird!" In reality, the indicator, may be giving a much more important signal, one of a "cyclical" or "secular" change in the market, opposed to a directional signal, that indicates simply a change in the direction of price.

Copyright © 2003 All rights reserved. Ike Iossif President & CIO Aegean Capital Group, Inc. & Executive Producer MarketViews.tv Expert Page Ike's Bio Commentary Archive Ahead of The Trend on FS Newshour

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[Beck_isright]

Just a reminder; 2 months ago Merrill came out and advised all clients to have at least 10% of their holdings in precious metals, and up to 15-20% if so desired. When they come out and advise Joe Schmo to buy gold and silver that means the big boys were buying months before.

That was the red flag I was looking for. Obviously they are anticipating another terr attack to be followed by a massive market crash.

[Soren]

My opinion is that we are still in the early stages of a multi-year bull market in gold and silver, but obviously I could be wrong. You need to educate yourself on the precious metals markets by visiting sites like gold-eagle, financialsense, 321gold, jsmineset, etc. and decide for yourself. This is crucial, because even if someone tells you what to buy today, they are not going to be there to tell you when to sell.

My advice is don't over-invest in gold/silver shares. This market is volatile (physical prices are not as volatile). If you become convinced we are in a gold bull, you need to either be good enough at TA to trade the swings, or have a small enough investment that you can sleep at night and not sell out at inopportune times. I have seen my PM portfolio go to +150%, down to +10% and back up to +200%. I was fortunate in my timing, but others who got on board a bit later started off taking losses.

For small investors who want physical gold, I think Krugerrands are the best value. There is a premium on Gold Eagles. For silver, you can buy junk bags (old US dimes and quarters that contain silver), 100oz bars, or silver eagles. You'll pay more per oz for the eagles. 1000oz bars need to assayed when you sell them. I have used ColoradoGold.com (Don Stott) and been happy with the service and prices. I have also seen tulving.com recommended.

You need to research each company: are they a producer or explorer, proven/inferred ounces in the ground, oz produced, cost per ounce, balance sheet, shares outstanding, political risk, etc.

One thing to understand is high cost means more leverage. For example, if a miner's cost per oz is $350 and POG is $380, profit is $30 per oz. If gold rises to $450, profit rises from 30 to 100. Compare that to a cost per oz of 200. Profit rises from 180 to 250. In the first case profits rose 233%. In the second, 39%. This is why gold shares offer leverage to the moves in the price of the metal. Some shares will move as much as 3-5x. Works in reverse too. Because of this leverage, it is often difficult to evaluate stocks using P/Es. The P/E can change dramatically if the POG makes a strong move. The shares tend to lead the metal, and this is the case right now. It looks like the shares are pricing in a near term rise, so be careful with your entry point.

Right now, I like the South African shares, but a lot of people shy away due to the political risk. Over the last year, they have under-performed because even though the POG was rising in US$, it was falling sharply in Rand due to the appreciating Rand. Since the SA miners pay their bills in Rand, their profits were squeezed. SA has enormous reserves. I own DROOY which is a high cost producer and therefore, very leveraged to the POG. Harmony is another good SA miner.

One final point, some of the miners have hedged their production, which means they have sold forward. This means they will not fully benefit from the rise in the POG. Big hedgers include Barrick and Placer Dome, which is why you often see these companies bashed on the gold boards.

Best of luck.

[Soren]

I agree with you. I am very bullish on silver and I have read many refutations of the digital photography "threat". That post was just a quick copy/paste based on a search I did to find something on Buffet.

Regarding China, I have read a theory (I think it may have been Murphy) that they were selling silver to depress the price so they could take over the silver refining business.

[razorback-bert]

2 months ago Merrill came out and advised all clients to have at least 10%

I missed this, did they just announce it in their newsletter?

BTW, I had voice message offering me a chance to buy a limited partnership in a wireless antenna on one the tallest building in NYC, but darn it, I fail to write down their number.

[razorback-bert]

on one

failed

Speer's 1st Law of Proofreading: The visibility of an error is inversely proportional to the number of times you have looked at it

[Orangedog]

Regarding China, I have read a theory (I think it may have been Murphy) that they were selling silver to depress the price so they could take over the silver refining business.

If that's what they're doing then it's not the smartest move the Chinese have made. In an environment of increasing commodity prices, I don't think they would want to deplete one of their natural resources so they can capture market dominance refining the resources of other countries, especially raw ore. You'd have to ship tons of the stuff and that would increase production costs when lowering production costs is the name of the game. IMO, if they are selling with the intention of keeping the price down, I think that they are doing it to help COMEX get more rope to hang themselves with it's massive short position. When the noose tightens in Chicago, expect China to suddenly cut back or halt it's silver sales. They already have us boxed in on the debt financing...this would just strengthen their hand further.

[arete]

Do most here think gold or silver is a good investment now?

Yes, gold and silver look good but I wouldn't just jump in with both feet at this point. Why don't you look around for a nice no load mutual fund that concentrates its investments in the precious metals area?

Richard W.

[Beck_isright]

Quite legit. They had one of their talking heads on CNBSC right before labor day saying it again. I find it interesting as they are not publicing this reccomendation heavily.

[Beck_isright]

Would that be a mutual fund under investigation or one not under investigation? The latter is going to be awful hard to find soon.....

[arete]

Would that be a mutual fund under investigation or one not under investigation? The latter is going to be awful hard to find soon.....

I myself am not all that crazy about mutual fund investing but it allows people to enter a new area and get the feel for it as they learn more about it. I don't think that the mutual fund business is any more or less corrupt than anything else on Wall Street. Remember when MER was recommending Japan to investors even as they themselves were shorting it? It's all a scam.

Richard W.

[Beck_isright]

What's amazing is that the networks still trot out Lynch and all the other scam artists without realizing that most mutual funds are as corrupt as WorldCom. Too bad the sheeple don't bother to read the fine print when they sign up for these funds.

[DarkWaters]

China has been making inroads with Chavez the last few years as well; Ecuador's newly found dictator has Chinese help; Lula seems to be growing Brazil's relations with China as well; the Chinese have built a deep water port in the Bahamas with the same front company in Panama and China's leading military leaders have signed the visitor's record. The Chinese are playing long term strategy and its for keeps, its just sad that those in this region and in our country, there seems to be no one who cares or there are those who want it to happen. Very few see a problem.

One has to wonder what strings they are pulling to help forment decent in some central and South American countries.

There is no doubt about it, but stuff like this usually remains behind the scenes in order to give China an arms length approach otherwise people would wake up. Another sad fact is that since South America has no united front against tyranny, it makes it that much easier for China to exploit the internal problems of each respective country.

[razorback-bert]

Oh, I didn't doubt you or it, I just missed it.