The stock market plunged, while gold rallied in a safe-haven bid after Congress rejected Treasury Secretary Paulson’s proposed $700 billion financial bailout package on Monday, September 29. While I think these trends will reverse in the short-term once some sort of relief package passes, in my opinion, the economy is weak and the stock market remains on shaky ground. I think we will continue to see a flight into gold and out of stocks until the global economy stops bleeding, and am recommending trading strategies accordingly.

The stock indexes started the day down Monday, and rally attempts failed as the market began to crumble as the day wore on. The Dow Jones Industrial Average plunged nearly 778 points, or 7 percent, it’s worst one-day drop ever, while the S&P 500 fell 106 points, or 8.8 percent and the Nasdaq Composite dropped 199 points, or 9.1 percent. A lot of people were speculating the bailout would be wrapped up Sunday, it would be signed, and the stock market would cheer the news. You can see the breakdown on the 5-minute chart of the E-mini S&P futures when that didn’t happen.

We saw a lot of buying come in around 12:30 on the chart in the middle of the screen, where you see a very large red candle, then a small green and large green candle. That’s when the news was reporting the Congressional vote and showing more “yeas” than “nays.” But then, the market turned and fell off steeply into the afternoon when the votes were finalized and the plan rejected.

You can see how the volatility is huge, and it’s tough to day-trade in this environment. You have to use a few different technical indicators, and you have to have a plan. If you had bought S&P futures Monday, you’d have to get out within several minutes or risk a big loss.

In my opinion, it’s tough to try to pick a direction in the short-term right now, given the volatility. If we pull back to a daily chart, you can see a clear downtrend in place. S&P futures could move up to 1260 and still be in a downtrend.

So, even if the market turns up on a bailout solution (which I expect will happen) that doesn’t necessarily mean all is well and the low is in. Not only are we seeing economic slowing here, but it’s spreading to other parts of the world. Europe, especially England, is about 6-9 months behind us in this housing and financial market debacle. The British pound and the FTSE have really gotten hammered as the housing crisis spreads to the U.K. and banks there are failing too. Britain’s government took control of mortgage lender Bradford & Bingley early Monday, while Belgium, the governments of Netherlands and Luxembourg took partial control late Sunday of struggling bank Fortis NV. We have to see Europe’s economy start to pick up to create a more bullish environment for stocks.

So, I think the S&P will likely cycle back up in the short-term, and then come back down. Initially, once the bailout passes, we’ll see a big rush of people thinking the bottom is in. But after that, people are going to pick apart the plan, and how it will affect taxpayers and our economy. I think the market is going to go on a wild ride. Until we can get a global recovery, then I think the stock market won’t be able to rise meaningfully.

The relationship between gold and the S&P has been interesting. They have been moving really inversely, as you can see in the chart below with gold futures in black, and S&P futures in blue. People were saying there was no cash left for the gold market, but gold has had a great move as investors flocked to safe-haven instruments. There have been some good opportunities to play this spread, especially at the openings, when we’ve seen some explosive moves in both directions.

I’ve been pretty bullish on metals for some time now. I do like silver too, but the sad thing about silver is that compared with gold, it doesn’t look that great. Silver is an industrial metal so it’s been impacted by demand issues on ideas the economy will sag further. Silver is not seen as a safe-haven like gold is. Gold is breaking away while silver, platinum and palladium are rolling over. 

December gold futures are showing an interesting technical pattern, a flag formation. As long as gold stays above the $860 – $875 an-ounce area, there is room for an extension upwards to new highs. The way you want to trade these flags is to keep your stop below the pennant, around the $870 low. A failure from there could indicate a pullback to $830.

If gold rallies up to around $920, I’d recommend picking up $870 or $875 November or December puts. Then wait for a break; if the bailout comes through we’d likely see gold decline sharply. I might then consider getting long gold futures around $890. With the options, you get a defined loss and unlimited profit potential. If you buy the futures, the put offers you a hedge.

Feel free to call me with any questions you have about this strategy or others to suit your particular account size and risk tolerance. Ask about our special half-off commissions offer for new clients.

Phillip Streible is a Senior Market Strategist with Lind Plus. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com.

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