GILD: Big pharma redux

Gilead Sciences Inc. (GILD) is making its second appearance on Private Trader in recent memory. I last wrote it up as a potential bull play late last year.

GILD is back, having broken above its 20-day price channel on Wednesday and confirmed the bull signal by trading still higher today.

The chart, however, is less bullish than it was before. The big rise from July 2010 that multiplied GILD's price by four appears to have ended, setting the stage for continued decline. The chart is quite ambiguous, but the balance of risk and reward favors a bearish opinion.

The Chart

I shall focus my Elliott wave analysis on both the recent past, the chart from the Feb. 25 peak of $84.88, and the history of the past 20 years. Any assessment of GILD's future must rest upon the interpretation of those few months.

For the intermediate picture, see the charts in my analysis from Nov. 25, 2013: "GILD: Bullish on big pharma".

Click on chart to enlarge.

GILD 20 years monthly bars (left), 24 days hourly bars (right)

There are two possibilities. By the long-term count, GILD has completed the wave 5 {+4}, the final wave of a rise than began with GILD as a penny stock in 1994.

That implies that GILD has moved into a downtrend rather than a correction. In a downtrend, the primary tendency of the chart is a decline. A downtrend will resolve itself at the highest degree into a five-wave decline.

The alternative would be to count the decline as a correction, perhaps a wave 4 {+3} within wave 5 {+4} on the 20-year chart on the left. A correction has a lot of possible patterns, but they resolve themselves into sets of three in the degree below the major tendency.

The chart since the February peak will support either case.

In the downtrend scenario, the low of $63.50 on April 11 is labeled wave 1. In the correction alternative, it is labeled wave A. Likewise, the rise from April 11 is wave 2 under the downtrend scenarios and wave B under the correction scenario.

Under either scenario, the wave up from $63.50 will reverse to the downside while below the Feb. 25 peak of $84.88. If wave 2 (or B) moves above the Feb. 25 peak, then it brings in a third scenario saying that wave 5 {+4} to the upside is not yet complete and the uptrend is continuing.

So far wave 2 (or B) has retraced nearly 78.6% of the decline from February to April. That's a large retracement and is nearing the Fibonacci level of 78.6%, at $80.30. If the two bearish scenarios -- downtrend or correction -- are indeed accurate descriptions of what is happening, then I would expect a reversal to the downside very soon, as wave 3 under the downtrend scenario or wave C under the correction scenario.

A C wave might well stay above the April low of $63.50, or it could push below it. A 3rd wave must move below $63.50.

If the correction scenario is accurate, then the C wave will upon its end begin a new five-wave rise that will eventually exceed $84.88. If the downtrend scenario is correct, then $84.88 won't be seen again and after a 4th wave correction, GILD will move to new lows.

That's a lot of ambiguity, but it is easily resolved. As long as the price remains below $84.88, then I have to assume that the tendency is bearish. Given the extent of the Fibonacci retracement, nearly 78.6%, then I have to assume that the wave 3 or C reversal will come quite soon.

Only a move above $84.88 will resolve the ambiguity entirely, but that is nearly 7% away.

Given the structure of the Elliott wave analysis, I see a greater likelihood that GILD will resume its downward course rather than breaking above February's high. However, it isn't conclusive, and all of the three scenarios I discussed remain in play.

Odds and Yields

GILD has completed one bear signal since the Feb. 25 peak. It was successful, yielding 1.6% over 27 days.

The Company

Gilead Sciences, a pharmaceutical company headquartered in Foster City, California, at the outset developed HIV therapies. It has since branched out into cardiovascular, respiratory, liver and cancer treatments.

Analysts collectively come down with a positive opinion of Gilead's prospects, with a 60% enthusiasm rating.

And with these financials, no wonder! Gilead reports return on equity of 41% with no long-term debt.

Heavy sales of a hepatitus C treatment called Sovaldi catapulted 1st quarter earnings to triple earnings in the year-ago quarter. With that exception, Gildead's earnings have been steady for the past three years, with eight upside surprises and three to the downside.

Earnings yielded 3.41%, compared to 2.61% for U.S. Treasury notes. Gilead's earnings yield is less than 61% of other biotechnology and drug companies. The company pays no dividend.

The stock is selling at 29 times earnings and also at a high premium to sales. It takes $8.83 in shares to control a dollar in sales. Institutions own 91% of shares.

Gilead next publishes earnings on July 28.

Liquidity and Volatility

GILD on average trades 23.2 million shares a day and supports a wide selection of option strike prices spaced $2.50 apart near the money. The front-month at-the-money bid/ask spread on calls i 4.5%, compared to 0.3% for the most heavily traded symbol in the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 33% and has been on a sharp decline from 53% beginning April 10. The S&P 500, by contrast, has volatility of 13%.

GILD's volatility is in the 32nd percentile of the one-year range, suggesting that trades structured as long option spreads, bought with a debit, have the greater chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $71.74 and $86.74 over the next month, for a potential gain or loss of 9.5%, and between $75.64 and $82.84 over the next week.

Contracts today are skewed toward puts, which are running 10% above their five-day average volume, compared to 89% of average for calls.

Decision for My Account

I'm declining to take a bull trade in GILD for the reasons outlined in the chart discussion. I'll add the symbol to the Watchlist for consideration above $84.88, the February high.

References

My shorter-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading. 

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.