Option Investor
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Be very careful if you're long!

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In the last couple of hours a few subscribers and I have notice that there appears to be a lot of buyers coming into bonds. At the same time the Gold/Silver Index (XAU.X) is moving higher as if it's filled with helium! In the past, this divergence has spelled big trouble for stocks. Even though we're seeing this divergence, it hasn't hurt the NASDAQ Composite (COMPX) yet. I think the key word here is "yet." Be very careful and let the S&P Banking Index (BIX.X) give you the needed input that you and I need right now.

10-year YIELD Chart (TNX.X) - 60-minute interval.

The past two rate cuts by the FED have actually seen bond yield rise after the rate cut. Today's action in the 10-year doesn't seem like the MARKET is anticipating a rat cut with YIELDS headed lower. The bond market closes at 03:00 EST and the action we're seeing in this bond looks like buyer are coming to the table (driving YIELD lower). Is this a "defensive" move? I'd think today's YIELD might be a defensive move in the market. If a "rate cut" is going to be good for stock, wouldn't I be selling a measly 5.04% yield and opting for the potential returns that stocks would bring? I would if I thought stocks could deliver a sustainable higher return.

Gold/Silver Index (XAU.X) Chart - 60-minute interval.

The Gold/Silver Index (XAU.X) plays an important role in three different scenarios. On February 16th I highlighted the XAU.X as a bullish play so that traders could perhaps benefit from two things that could fuel a move in this index. The first was a hedge against inflation and the second was a hedge against stagflation. I must say I thought we'd see profit taking in this index today, but we're not. We're monitoring the 53.23 level now and a move above that level would really start to get me thinking that the MARKET is very concerned about inflation and beginning to place some big bets on this indexes future.

S&P Banks Index (BIX.X) Chart - 60-minute interval.

Today's action in the banks as represented by the BIX.X has me starting to think that the MARKET isn't concerned about stagflation. I can use my retracement bracket to try and ascertain some levels to be monitoring, but I'm focusing more on two horizontal trends. The thick red horizontal trend was a level we had identified sometime ago as a "key" level to be monitoring, as it would alert us to the potential of "stagflation." Currently, it would take a sustained move above 643 to have me believing the market wasn't concerned about stagflation. Banks and Gold/Silver can still move higher in a moderate inflation scenario, but often times we see bond YIELDS follow that move. It's today's bond YIELD that has be hesitant to put too much faith in equities at this time.

Ifs, ands or buts!

However, if we were to see the Gold/Silver Index (XAU.X) start to give back gains and the S&P Banking Index (BIX.X) continue to move higher, I'd view this as a positive for stocks. But unfortunately, the bond market is now closed and we can't benefit from it any further today. Equity bulls really want to see bond YIELDS and the gold/silver index move in the same direction, but they don't want to see them move in the opposite direction. I'm also watching the QQQ's closely and while this index is "drifting higher" it has yet to challenge our retracement bracket level of $61.8% at $54. Traders can begin to see (hopefully) how all of this starts to meld together. If we see the XAU.X start breaking down.

Jeff Bailey
Staff Analyst

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