 Trading
the Gold-Stock Bull 4
Adam Hamilton
Archives
February 20, 2004
The ongoing consolidation/correction
in gold and gold stocks seems to be spawning a great deal of
consternation amongst the contrarian community. Gold and gold
stocks have been relentlessly grinding sideways to lower for
a couple of months or so now.
The Ancient Metal of Kings
itself carved its latest interim high around $426 in early January,
and has been struggling ever since. The flagship HUI unhedged
gold-stock index has not yet witnessed another new bull-to-date
interim high since early December, when it closed near 257.
For those of you keeping score
like I am, that was 11 long weeks ago since gold stocks assaulted
fresh new territory on the upside! As always when the markets
do not seem to behave and cooperate with a given worldview, a
broad cornucopia of theories has bloomed to explain the recent
dearth of progress in the gold and gold-stock worlds. Some of
these theories are excellent, some are plausible, and others
are just plain absurd.
As a mere mortal speculator
with imperfect information, I do not know with 100% certainty
why gold and gold stocks corrected. Maybe alien voodoo high priestesses
living deep under the polar ice caps on Mars really did use an
interplanetary mind-control ray to blast gold-market psychology
negative. But maybe there is a far simpler explanation than some
of these more outlandish correction theories!
Since we humans can never even
hope to be all-knowing omniscient speculators, we have to deal
in the realm of probability. Anything is always possible in the
markets, but some things are less probable than others. For example,
if I said that gold ought to trade $10 higher next week, you
would have no problem accepting this idea since it is an event
that has happened often in the past and has a high probability
of occurring again.
But if I was to claim that
gold ought to trade $10,000 higher next week, you would laugh.
Why? You instinctively know from watching and trading the markets
that a 25x gain in a single week on a global asset already approaching
$2t in value is madness. Sure it could happen, but odds are that
it never will!
In trying to understand why
the gold markets corrected in recent months, we need to weigh
all of the competing theories in terms of probability. The principle
of Occam's Razor is very important in formulating market theories.
We should not make any more assumptions than absolutely necessary
and we should look for the least complicated and most simple
explanation for the ongoing consolidation/correction in gold.
The simplest explanation also has the highest probability of
being the correct one.
So if we whip out Occam's famous
razor and slice away all of the nonessential theories and variables
on the gold correction, what are we left with? I believe that
the simplest explanation is merely that gold and gold stocks
were short-term overbought in recent months, and needed a breather
before launching the next stage of their glorious bullish ascent!
It sounds trite, but markets
go up and markets go down. Even within long-term primary secular
trends, countertrend moves, such as a gold correction a powerful
gold bull market, are fairly common and ought to be expected
periodically. Indeed, this current correction in gold was expected.
I have written about it extensively and my clients and subscribers
were ready and waiting for it in advance.
This week I would like to review
and update the key technical charts that alerted my team and
me that a gold and gold-stock correction was expected and coming.
I have been warning of this in our monthly Zeal
Intelligence newsletter, our anytime Zeal
Speculator alert service, and in these weekly Web essays.
Where appropriate, I will quote from these earlier dispatches
so you can see for yourself how this correction was certainly
no surprise to vigilant gold and gold-stock speculators.
Even more importantly, however,
these very same charts will help us to discern the golden opportunity
when the gold and gold-stock consolidation/correction is nearing
its end. These are among many indicators that we have painstakingly
developed and continue to watch that will help alert us and our
subscribers to the ideal moment to deploy heavily long again
to ride the next massive upleg in gold and gold stocks.
After you review these charts,
I hope that you will have a deeper understanding about how there
are both high-success-probability and low-success-probability
moments in time to go long a secular gold bull in terms of short-term
speculations. Our goal continues to be to only trade during the
high-success-probability opportunities while we patiently sit
out the low-success-probability times.
Our first chart this week shows
Relative Gold, or the price of gold divided by its 200-day moving
average. It illustrates just how far above its key 200dma that
gold happens to be trading at any given moment, in perfectly
comparable constant-percentage terms. A reading of 1.10, for
instance, indicates that gold is trading at 1.1x its 200dma,
or 10% above this key technical level.
In any major long-term secular
bull or bear market, short-term countertrend moves are natural
and inevitable. The long-term 200-day moving average is the almost
magnetic line that many of these short-term countertrend moves
tend to seek out before they reverse. On almost any price chart
of any market from any era, you will see Great Bull and Great
Bear trends continually extend away from and then periodically
retreat back to their own all-important 200dmas.
In our young bull market in
gold to date, which launched in early 2001, gold has approached,
kissed, or momentarily breached its key 200dma support a half-dozen
times. But, since this is a powerful bull market based on a long-term
global supply and demand deficit of physical gold, the primary
trend remains pointed towards the heavens. As such, each countertrend
200dma correction in gold was short-lived and heralded the advent
of another glorious vault higher.
While most folks have no problem
understanding the great logic of buying near 200dma approaches,
it continues to amaze me how many people choose to brazenly ignore
the obvious corollary. When gold gets extended too far above
its 200dma, it is simply short-term overbought and a short-term
correction is due. We don't need to worry about Martian voodoo
priestesses when Occam's Razor can slice away all of that nonsense
and leave us with the normal ebb and flow of a secular bull market.
If you look at the blue gold
line relative to the black gold 200dma line above, you can generally
see when gold is close to or far from its most important long-term
support line. As the bull market progresses, however, this visual
comparison rapidly becomes skewed. Earlier days appear to be
tiny visually while recent months dominate a chart. We developed
Relative Gold to address this limitation, to provide a perfectly
comparable constant-percentage reading of the distance that gold
happens to be from its key 200dma.
The red line above mathematically
quantifies Relative Gold through time. In our fabulous bull market
in gold to date, gold has tended to oscillate between just under
1.02x its 200dma to just over 1.11x its 200dma. Now if you examine
this chart carefully, you can see that this Relative Gold line
helps speculators determine when high-success-probability opportunities
to buy or sell gold happen to exist.
On the low side, any time that
Relative Gold trades under 1.02 or so, the green buy line rendered
above, speculators have been blessed with a fantastic opportunity
to deploy short-term gold-related speculations on the long side.
In addition, these very same moments are the ideal time for long-term
gold investors to increase their own positions when they wish
to feed fresh capital into the ongoing gold bull. Buy low!
As the chart above clearly
shows, every single time that gold has traded within 2% of its
200dma a major gold upleg has ensued shortly after. Mid and late
2001, late 2002, early and mid 2003, they all marked ideal moments
to throw aggressively long and prepare for the next major upleg
in gold. So, next time Relative Gold trades under 1.02, get ready
to buy any new positions that you want to deploy, regardless
of if you are a speculator or investor.
Even within a primary bull
though, major uplegs are finite and are inevitably followed by
corrections. As the chart above shows, once Relative Gold breaks
1.11 or so to the upside it is time to go neutral, as odds are
that the current gold upleg is finally drawing to an end. In
our bull to date every single time that gold has traded more
than 11% above its key 200dma marked short-term topping periods
prior to significant consolidations and corrections.
I don't call Relative Gold
1.11 a sell signal though, just a neutral. The reason is that
in a primary bull market the probability of a massive unexpected
upside breakout always exists. There is no sense in liquidating
long speculation positions any sooner than the markets force
us to!
If you are a long-term investor
and see a Relative Gold reading above 1.11, you can just ignore
it. But if you are a short-term speculator you ought to considerably
tighten up your trailing stop losses on gold positions in anticipation
of a coming interim top and short-term correction once Relative
Gold 1.11 is exceeded. If the markets correct aggressively enough,
you are simply stopped out of your open positions with awesome
realized profits. Piece of cake!
Now applying this sound trading
theory to real life, Relative Gold broke 1.11 to the upside on
December 1st, a crystal-clear signal for speculators to prepare
for an interim top and ratchet up their trailing stops. If anyone
tells you that this correction was unanticipated, they are not
telling the truth. On December 5th in my "Trading
the Gold-Stock Bull 3" essay I wrote.
"While the long-term secular
gold bull that now challenges $400 almost certainly has many
years left to run yet, with the best gains lying ahead still,
speculators still need to expect normal healthy short-term pullbacks
to higher lows after major rallies. With gold stocks shooting
vertical and both of our gold-stock indicators now neutral, speculators
ought to prepare and gird themselves for just such a correction."
Remember Occam's Razor? No
complicated theories were necessary to anticipate this ongoing
consolidation/correction. Simple technical market rhythms were
completely adequate to protect yourself from this predictable
short-term gold weakness. Gold was overbought, a correction was
due, and here it is. No big deal. And there is no rocket science
or Martians necessary!
These periodic 200dma-convergence
countertrend moves happen in both bull and bear markets alike.
Since gold is the ultimate form of money, the dollar gold price
is essentially the exchange rate between mighty gold and the
fragile fiat-paper US dollar. As such, any short-term dollar
strength within the dollar's secular bear will often translate
into short-term weakness in gold in dollar terms. Comparing the
Relative Dollar to Relative Gold can warn us of potential approaching
bear-market rallies in the US dollar.
This second chart shows the
exact same Relative Gold line rendered in the first chart above,
although it is colored in blue this time. The second red line
here is the Relative Dollar, the US Dollar Index divided by its
key 200-day moving average. Since the dollar is in a secular
bear market, it is usually trading below its 200dma so its Relativity
reading is generally less than 1.00 these days.
The interesting thing that
we were watching in early January when I first wrote about this
chart was the nearly 0.90 Relative Dollar reading at the time.
The dollar had bounced near 0.90 and entered major bear-market
rallies in each of the previous years, so 0.90 looked like a
potentially dangerous level for gold this time around too. Any
dollar bear-market rally would lead to a lower US dollar/gold
exchange rate, or gold price, over the short-term.
In recent years each time that
the US Dollar Index entered a countertrend bear-market rally
back up towards its overhead 200dma, gold fell right along with
it. You can see this in the chart easily in Relative Gold terms.
When a dollar bear-market rally kicked off, gold retreated from
levels high above its own 200dma back down to levels right near
its 200dma. As such, a low Relative Dollar coupled with a high
Relative Gold was another crystal-clear technical warning signal
for speculators.
On January 9th, incidentally
the very day that gold carved its latest interim top, I discussed
the first iteration of this chart in my essay on "The
Relative Dollar and Gold." It heralded a coming consolidation
or correction in gold so that is what I wrote about. And, believe
me, it is no fun at all writing about gold pullbacks when new
bull-to-date highs are being achieved, as an analyst is instantly
vilified by thin-skinned gold investors who feel threatened when
anyone dares suggest that gold is not going to rise by 10% a
day for the rest of eternity.
I closed that essay with, "For
now though, the oversold dollar levels and overbought gold levels
in Relativity terms are troubling. The US Dollar Index really
looks like a major countertrend rally is imminent and due. And
if a bear-market rally in the dollar launches, for any reason,
odds are that gold is going to get hit over the short-term. Get
ready!"
Why was I concerned on January
9th as gold carved an interim top? Not because I believed in
Martian voodoo priestesses and mind-control rays, but simply
because the markets ebb and flow and the dollar was about due
for some short-term flowing strength. Why even consider complex
and inherently unprovable theories on the gold correction when
a simple and anticipated technical market rhythm can easily explain
these things?
For speculators, the best time
to throw long gold in anticipation of a major upleg is when both
Relative Gold and the Relative Dollar converge near 1.00 or so.
Just as a Relative Dollar level approaching 1.00 heralds the
end of a major bear-market rally in the US dollar, the Relative
Gold level near 1.00 that we discussed above marks the end of
a major gold correction. It pays big to stay abreast of these
important technical developments if you are a speculator!
Gold stocks have been weaker
for over five weeks longer than gold itself now. Just as the
correction in gold was natural, normal, and fully expected by
vigilant speculators, so was the correction in gold stocks. Our
final chart this week showcases the HUI and Relative HUI, computed
using the same simple methodology discussed above. Just as we
witnessed in gold, the HUI also advances far above and then corrects
back down to its key 200dma periodically. All markets rise and
fall, ebb and flow.
Just like gold or any trending
market, the HUI also oscillates between conservative levels near
its 200dma and extreme levels far above its 200dma. In Relative
HUI terms, we have been using the range of 1.05 to 1.50 for general
gold-stock speculation signals. When the HUI crosses under 1.05
speculators should consider aggressively throwing long gold stocks,
and when it exceeds 1.50 they ought to consider raising their
trailing stop losses in anticipation of a correction.
Indeed, every single time that
the HUI traded under 1.05 in the chart above it has preceded
a major upleg in gold stocks. If you are looking for high-success-probability
moments to either deploy fresh long short-term gold-stock speculations
or add to your existing long-term gold-stock investments, it
is hard to beat an opportune moment when the HUI corrects back
down to within 5% of its key 200dma.
On the other hand, contrary
to the deep faith held by the fervent gold-stocks-to-the-moon-today
zealots, gold stocks, just like every other bull market in history,
move both up and down. Yes, the general long-term secular trend
is gloriously higher and will be for a long time with such awesome
fundamentals, but short-term consolidations and corrections are
healthy, natural, and normal.
Either fearing or becoming
irritated by a short-term gold-stock correction is as completely
irrational as getting upset that every sunrise is followed 12
hours later or so by a sunset. Markets, prices, and general emotions
ebb and flow, moving up and down in endless cycles. Trading with
the long-term trends like the gold-stock bull is very wise, but
growing upset at short-term deviations from these long-term trends
is a total and complete waste of time, a telltale mark of speculator
immaturity.
The HUI, like any bull market,
can become overbought over the short-term and in need of a healthy
correction. As the Relative HUI 1.50 neutral line above illustrates,
every single time in this bull market to date that this level
has been exceeded a correction and/or consolidation closely followed.
Anytime the HUI is trading more than 50% above its 200dma, extreme
caution should be exercised by gold-stock speculators as odds
are that a short-term interim top preceding a major pullback
is near.
In current terms, the Relative
HUI broke above 1.50 this time around on November 28th. Two days
after the HUI carved its latest interim top on December 2nd,
I warned our Zeal Speculator alert-service subscribers
about the imminent pullback. On December 4th I wrote, "Nevertheless,
stops are very important here since the gold stocks are so short-term
overbought at these levels. Please watch your gold-related speculations
and be ready to get out if your stops are hit or prices fall
rapidly."
Dear friends, this gold-stock
consolidation/correction was fully anticipated by vigilant speculators!
There was no need of magic or complex theories either, as the
Occam's Razor of crystal-clear technical developments highlighted
this growing short-term risk on the long side of gold stocks.
There is no reason that this correction should have surprised
anyone.
On the bright side, as this
HUI chart illustrates, the Relative HUI is already bleeding off
the speculative excesses of late November and early December
rather nicely. The HUI has still not retreated close enough to
its key 200dma to enter the high-success-probability strong-buy
zone under 1.05 yet, but it is getting relentlessly closer and
will probably be hit in the coming weeks or maybe months on the
outside.
Naturally we will continue
tracking all of these indicators that we have developed, and
more, in our acclaimed monthly Zeal
Intelligence and anytime Zeal
Speculator newsletters for our subscribers. When the time
comes to throw aggressively long again, we have already researched
the most promising gold-stock picks to buy for the next major
gold upleg, which I discussed in depth in recent issues of Zeal
Intelligence.
I am ready and eager to recommend
each stock specifically and buy them once we see the telltale
technical signatures suggesting that this short-term gold consolidation/correction
is drawing to an end. Please consider honoring us with your subscription
today if you want to know when this coming fantastic buying opportunity
has arrived! We are committed to only launching major trades
when the probabilities of success swing wildly in our favor!
To wrap up this fourth installment
of my essays on trading gold stocks, it is crucial to realize
that the current gold and gold-stock weakness was not random
but was anticipated on the record in advance.
As a speculator you can choose
to believe crazy theories about this development, choose to waste
your energy by getting angry and arbitrarily assigning blame
to someone else for this correction, or you can just accept it
and live with it. I choose the latter.
I do not care at all why this
correction is happening. Who cares and so what? It is not relevant.
But I do care about attempting to only buy low by not getting
caught up in the incessant hype and maniacal rantings surrounding
recent gold developments.
The simplest and cleanest Occam's
Razor explanation for these events was that gold and gold stocks
were merely short-term overbought and needed to blow off some
speculative steam. Odds are that Martian voodoo priestesses had
nothing to do with it!
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
February 20, 2004
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