Why Volatility Is the Most Undervalued Asset In the World

“The lapse of time during which a given event has not happened is…alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.” – George Eliot's Silas Marner

“The stock market continues to represent above average risk. The action of the indexes and the Usual Suspect leading names such as TWLO, MDB as well as AMZN and AAPL warn that there is a change in character in the market. Breakouts do not act well. AAPL is a good example. What I’ve warned about is beginning to play out.

If you act as if it’s business as usual, you’re going to have a problem.”

The above is from Monday morning’s report before the SPX left a Breakaway Gap through a trendline connecting the December and June low, knifing below its 50 day line in the process.

Monday’s plunge represents a troublesome trifecta for the market:

1) The SPX broke with authority below its October and May peaks.

2) It snapped a rising trendlne connecting the December and June lows.

3) It left left a Breakaway Gap below the widely watched 50 day moving average.

A lot of damage was done in the generals and the glamours…the big cap leading names and the speculative growth glamours as volatility electrified all asset classes:

In addion to the popular stock indices, gold and TLT, the bond ETF exploded.

Exemplifying the surge in volatility was Monday’s SPX action.

Before the open, the futes were green.

By the opening bell they were red, sinking nearly 60 points before reversing.

On Tuesday morning the SPX was rejected from the key 2880 region, which represents the pivot point where the Dec/June trendline broke, Wednesday saw a round trip with the index closing at 2884.

Here’s the blow by blow as the day unfolded on our private twitter feed (pacific time):

7:06 a.m. SPX testing Monday’s cash low. Is this enough for a rally attempt for a B wave down?

Watch AAPL as the tell on its possible test of 193.

7:38 a.m. back up to this 2866 SPX level is important. Remember it is 270 degrees down from the all-time high.

So this will be an important inflection point.

8:56 what happens over the next 1 to 2 years is going to be determined by what happens over the next few weeks.

In the micro view a lot comes down to this move today. Do we get 5 waves down off the highs or not to the 2800 region on the SPX cash will likely be determined right here. It’s going to be an interesting and pivotal day to say the least

9:24 a.m. notice that following this morning’s gap down the SPX rallied to tag it’s overhead 20 hour m.a. again where it has been rejected …again. If it should clear the 20 dma. (2860ish), a rally to 2900 may play out over coming days/hours.

10L16 a.m. AAPL (197) coiled for a possible little hourly breakout from an hourly Cup & Handle may imply a rally attempt in SPX up to 2880 prior highs from yesterday…through there could extend

10:58 a.m. above 2866 elicited a whoosh up to the key 2880 level. We may clear it as the index is nicely through its 20 hour m.a.. That potentially puts 2920 on the radar which is 180 degrees down from the all-time high

11:02 SPX pulls back from the key 2880 region again. Remember this is the trendline connecting the Dec/June lows that was broken with authority. So now there are 3 not so little peaks at this 2880 region setting up a possible Rule of 4 Breakout…a breakout through a 3 point trendline. If we should push above 2880 and sustain, then SPX theoretically could extend over coming hours/days to gap window and gapfill from Monday and the overhead 50 day m.a.. this coincides with the idealized 2920 level…180 degrees down from high.

In sum, the SPX left a large range reversal on Wednesday. Pundits were quick to exclaim that it mirrored the large range reversal at the December 26th low.

However, it is to be remembered that the December 26th reversal followed a 3 month selloff and occurred on a waterfall decline below the 200 day moving average.

Wednesday’s reversal occurred just 8 days off the high and the index has not even breached its 200 day moving average.

Not all reversals are created equal.

The confirmation that the December reversal would lead to a change in trend came from a method I developed using the 3 Day Chart. It is called the Plus One/Minus Two Method.

The 3 Day Chart turns up with 3 consecutive higher daily highs intraday highs, not closing highs).When the 3 Day Chart is pointing up this satisfies the Plus One part of The Method.

The next time an item has 2 consecutive lower daily lows satisfies the Minus Two part of The Method.

So two consecutive lower daily lows while the 3 Day Chart is pointing up puts an item in the +1/- 2 buy position.

This is a SETUP for determining the daily trend.

Like any strategy, it is the subsequent price action following the signal that is key.

Follow through is always key.

Checking back to late December, notice that the 3 Day Chart turned up immediately off the low, on December 28th as the SPX traced out 3 consecutive higher daily highs on December 28th.

On January 3rd the SPX carved out 2 consecutive lower daily lows putting it in the Plus One/Minus Two buy position.

The next session the index turned up with authority precipitating a persistent 4 month advance into May 1st.

Let’s take a look at the current complexion of the market using my Swing Method.

The SPX turned its 3 Day Chart down on August 1st.

A higher intraday high today above Wednesday’s high will put the index in the opposite position as it was in early January.

This is because the 3 Day Chart is pointing down for a Minus One and the two consecutive higher highs now will satisfy the Plus Two part of the strategy.

The SPX could go into the Minus One/Plus Two sell position today.

In that respect, this setup would present following a stab down from a spike to a high in a potential mirror image of the Plus One/Minus Two buy setup in early January.

It is to be considered that with the explosion of volatility just as was the case last December, that if failure plays out, triggering our Minus One/Plus Two sell setup, it could be fast and furious with the SPX diving below its 200 day moving average.

Additionally, a failure on a backtest of the broken Dec/June trendline into gap window in the 2890-2930 area could install the right shoulder of a Head & Shoulders topping pattern.The left shoulder would be the May high, the July highs are a possible head.

A failure from a somewhat lower high from 2890 to 2920 could be a Droop Right Shoulder.

These are often quite bearish.

A break of the 200 day moving average warrants caution it has been tested successfully twice since the December low.

These two tests/undercuts of the 200 day occurred in early March and early June carving out a double bottom in the 2720 region.

The third test of this region may not be a case of the third time a charm for the bulls

Conclusion: Volatility has been the most undervalued asset in the world, but it is getting more expensive as risk is being price in in assets across the globe.

TLT went parabolic this week as it came out the top of a trend channel.

Readers know that we’ve been all over gold and precious metal miners since our expectation of a significant low in May played out.

Subscribers killed it in calls in GLD as well as plays in GDXJ and silver miner AG.

like TLT, GLD went parabolic on Monday as the SPX broke down.

GLD came out of a consolidation on Monday.

Flat consolidations can be considered corrective with an overbought condition being worked off in time versus price.

142/143 is an projection in GLD we calculated in June.

It is 180 degrees from the 119/120 low.

GLD may respect this level with some backing and filling but it is in a vertical move now.

A tornado of volatility is swirling over asset classes as they become untethered from the central bank reigns.

The roof may be off in gold as it cleared 50% of its prior bear market (1480).

We’re not in Kansas anymore.

If a currency war turns into a currency crisis, gold could see multiple days of gappage higher.

Gold is in a runaway move. Upside surprises happen in runaway moves which often take the form of sudden gaps higher. This can make it difficult to establish or re-establish long positions.

A 50% advance from golds 1046 bear market low equals 1569.

50% of the golds bear market is 1480 which has been reclaimed.

This 90 dollar region in gold will tell if a short-term buying climax is at hand or if it’s on the verge of rocketing higher.

Gold bull markets are backstopped by a lack of faith in governments.

A currency war/crisis serves to discredit the Sovereign suspects.

Pos GDXJ, GOLD, SBGL, SSRM