 Trading the Gold-Stock
Bull 5
Adam Hamilton
Archives
April 8, 2005
With the flagship HUI unhedged gold-stock index languishing near
200 for the better part of a quarter now, sentiment among gold-stock
investors and speculators is understandably pessimistic.
After all, it is recent price action that drives current psychology,
and with gold-stock prices meandering sideways from anywhere
between 3 to 18 months depending on your perspective, it is natural
for enthusiasm to wane. And as goes sentiment, so follows the
perpetual debate on the market.
Bull markets tend to climb walls of worry, and nothing brings
out swarms of worries as effectively as stalling prices. In the
HUI's case, its recent lack of performance is causing all kinds
of bearish theories to gain prominence. And if the gold-stock-investing
Internet forums are a valid reflection of general sentiment,
there is a growing firestorm of worries tormenting gold-stock
investors.
I started following Internet gold forums back in 1998, well before
gold's secular bottom in early 2001, and to this day I still
find them very valuable for getting a read on prevailing sentiment.
As I pondered the state of the HUI this week and monitored the
forums, a virtual cornucopia of bearish predictions burst forth.
The hardcore deflationists think gold stocks are doomed because
they believe the gold bull is over. Per this thesis, as soon
as the massive debt bubbles plaguing the US implode, prices of
everything from gold to groceries are going to be sucked
into a giant deflationary black hole. Why buy the HUI if the
debt implosion looms?
Meanwhile the perpetually victimized feel convinced that shady
big-money syndicates are actively shorting the gold stocks into
oblivion, trying to break the back of the growing pro-gold outlook
among small investors. Since these nameless forces allegedly
have unlimited money and the gold-stock sector remains so small,
why even bother fighting them?
Still others are mesmerized by the growing chorus of predictions
for a mega bear-market rally in gold's arch nemesis, the
mighty US dollar. Even some contrarian gurus are calling
for a 25% mega-rally from the dollar's late December lows, an
event which would almost certainly beat the tar out of gold.
Why buy the HUI if the dollar is about to become the global currency
darling again?
I find these bearish theories fascinating in the aggregate, all
considered together as a single trend. They are each bricks helping
build the wall of worry terrorizing would-be HUI investors and
speculators. But as King Solomon wisely wrote millennia ago,
there is nothing new under the sun. Negative sentiment is the
expected and natural response from prices not rising fast enough
to excite, and it has accompanied every gold or HUI interim
low in this entire bull to date.
In late 1999 when gold ground down to just above $250 on the
eve of the Washington Agreement, the forums were calling for
sub-$200 gold and the Elliott Wave bears were having a field
day. In late 2000 when the HUI bottomed under 36 and was just
preparing to launch its mighty 614% bull, the forums were convinced
central banks would never "let" the gold price rise
again. At gold's secular bottom in early 2001, once again popular
consensus near $260 was that gold was likely to see $200 before
$300.
And each time the HUI has corrected since then, negative theories
have gained prominence buttressing the wall of worries. It is
natural for market players to feel negative when prices aren't
rising rapidly enough, and this psychology leads to a theory-selection
bias that elevates congruent bearish theories and chokes out
contrary bullish ones.
But if we can rise above the tactical melee and regain the big
perspective, when the majority of gold-stock players wax bearish
it is a fantastic omen for contrarians. True contrarians remain
neutral internally, and as Warren Buffett so eloquently stated
they buy when others are afraid and sell when others are brave.
It sure seems like gold-stock players are generally afraid today,
a crucial clue that another interim bottom is probably being
laid.
This week I would like to discuss the current state of the HUI
from a variety of technical perspectives, ignoring the wall of
worries and instead focusing on hard price data. From my battle-hardened
perspective, the gold-stock bull continues to look healthy
and indeed on the verge of its next major upleg. When prevailing
technicals slice through the incessant sentiment noise, a very
bullish picture emerges.
We'll look at trading the gold-stock bull from a volume perspective,
examine the ongoing effects of the maturing countertrend
currency reversals, and finally look at my favorite gold-stock
trading indicator that has proven so incredibly profitable in
this bull to date. Today's HUI correction is nothing to fear
and it is probably well on its way to fully running its course
and embarking on its next major upleg.
This first chart examining
HUI volume is new since the last
essay in this series but was described in depth in last autumn's
"Trading
HUI Volume." This particular indicator is really interesting
since the HUI itself doesn't actually have volume!
Since HUI shares don't exist, it is just a tracking index, we
developed a composite HUI volume by adding up the individual
daily trading volumes in all of the HUI's individual component
companies.
This composite HUI volume yields important technical clues for
investors and speculators wondering what is going on with gold
stocks, whether now is a good time to buy or not. Contrary to
the rotten prevailing sentiment, the 5-day moving average of
composite HUI volume indicates that we are near a high-probability-for-success
opportunity to once again throw long gold stocks in a
big way.
Volume, interestingly, is tied directly to sentiment. When investors
get really excited about the HUI's prospects near major tops,
volume often surges as folks rush to buy as fast as they can
so they don't miss the boat. Conversely, when investors are terrified
volume also spikes dramatically. Thus high volume typically
marks major interim tops or the sharp plunges that usually
follow unsustainable near-vertical ascents.
Low volume, on the other hand, usually corresponds with waning
interest in a market. When prices don't appear to be doing anything
notable, like the HUI's today, gradually gold-stock investors
and speculators lose interest and just don't trade much. Prices
are typically lethargic without real volume. Low volume also
corresponds with a grinding low-level fear very different from
the sharp fear driving plunges. This low-level fear is spawned
by prevailing bearish sentiment like today's scaring people into
not trading gold stocks.
But if you carefully examine this chart, low-volume episodes
also mark some of the best times to throw long the HUI. When
the 5dma of composite HUI volume decays under 16m shares, the
green bar above, the HUI is usually just finishing a major correction
or consolidation and is ready to rock and roll again. Every low
volume episode of the last several years is highlighted above
in blue and they really do tend to mark fantastic times to buy.
Low volume also coincides with the HUI correcting back down to
its linear support line. In any secular bull market, one of the
highest-probability-for-success times to buy is when a price
retreats back to support in a normal, healthy bull market correction.
So far in 2005 the HUI has kissed support twice now, each time
accompanied by the telltale low volume. Once again today the
HUI composite volume threatens to fall under $16m shares on a
5dma basis.
In every previous case the HUI rallied not long after
these lethargic low volume periods were registered. Some of these
rallies sown in the depths of low-volume despair were relatively
modest, running for a couple months. Others were truly massive
primary bull-market uplegs that blasted higher for several quarters
generating enormous profits for gold-stock investors.
Will this time be different and not portend an imminent
HUI rally? I really doubt it. Low volume episodes are common
at major interim bottoms in pretty much all secular bulls. It
is natural human nature to get the most fed up with trading near
major bottoms when nothing exciting seems to be happening so
volume dries up right as prices are done correcting and once
again ready to thrive.
Our second chart highlights what I believe is the cause
of this HUI correction, the ongoing parallel currency
countertrend reversals in gold and the US dollar. This is
a Relativity
chart, showing both currencies as a multiple of their key 200dma
baselines over time. If you are not familiar with this approach
it is explained in more depth in December's "The
Relative Dollar and Gold 3" essay.
The only reason to own a gold
stock is because gold is in a secular bull market, a subset of
the Great Commodities
Bull of the 00s now underway. The higher gold prices rise,
the greater the profits of the unhedged gold miners multiply
and the higher their stock prices ultimately run. But since gold
drives gold-miner profits and hence gold-stock prices, the HUI
is at the mercy of gold corrections as well.
Gold itself still sojourns in the initial stage of its three
stage bull, where it still remains subject to the whims of
the parallel secular
bear in the US Dollar Index. Until global investment demand
grows great enough to lift the gold price independent of currency
machinations, gold will remain weak each time the dollar has
one of its periodic bear-market rallies. And since December,
as expected,
the dollar has been in bear-rally mode.
Both secular bulls and bears alike tend to diverge away
from their 200-day moving averages to extend their primary trend
and then periodically retreat back to their 200dmas to maintain
balance in sentiment. When gold is rising and the dollar is falling
both currencies are diverging from their 200dmas. But when the
inevitable temporary countertrend reversals arrive, like today,
both currencies converge with their 200dmas.
The chart above outlines this well-established phenomenon. In
December both gold and the dollar diverged relatively far away
from their respective 200dmas and sentiment was waxing extreme
in both cases, bullish for gold and bearish for the dollar. Since
this extreme sentiment is not sustainable, soon the dollar entered
bear-market rally mode and gold corrected, converging with their
200dmas represented as 1.00 in this relative chart.
The bold yellow lines above highlight the mirror-image pattern
in gold and the dollar in relative terms. When the dollar is
weak gold is strong and when the dollar is strong gold is weak.
And of course since gold ultimately drives the gains in the HUI,
the premier gold-stock index also suffers while gold is grinding
through one of its periodic corrections.
The HUI's current gold-weakness-driven correction is no surprise
at all for prudent investors and speculators who understand this
critical relationship, indeed we have been expecting
and predicting
it. All bull markets flow and ebb, taking two steps forward and
one step back. Corrections are natural and healthy in all bulls
as they keep sentiment in balance and prevent the secular bull
from maturing too quickly at too low of price.
Our Relativity trading bands that will probably signal the end
of the current gold correction and dollar bear rally are marked
above. Once gold falls under 0.99x its 200dma, and the
US Dollar Index exceeds 1.00x its 200dma, then the threat
of the correction will be largely past and investors can redeploy
for the next major gold and gold-stock upleg. We are getting
very close on both accounts, as a new bear-rally-to-date rDollar
high was just carved this week.
If you would like to follow this rapidly approaching major long
signal in gold and short signal in the dollar, our newsletter
subscribers
gain access to an exclusive section of our website with large
charts of rGold and the rDollar updated twice a week or so. Since
these relative signals have been so profitable bull to date I
keep a close eye on them and use them to guide my own gold-stock
trades.
Understanding the current relationship between gold and the dollar
is crucial for protecting yourself from getting caught up in
the prevailing bearish sentiment. As long as gold remains in
the initial currency-driven stage of its bull market, it will
correct when the dollar periodically rallies. And during these
healthy gold corrections the HUI will be weak, consolidating
or correcting, since it is the gold price that ultimately drives
the stocks of the companies that mine gold.
Thus everything we have witnessed so far in 2005 is merely par
for the course. There is nothing special, scary, or anomalous
about the latest HUI weakness compared to its bull-to-date behavior.
With the root cause of the HUI correction understood, our final
chart gets back into trading the gold-stocks directly. It is
also a Relativity
chart, with the rHUI line showing where the HUI has traded as
a multiple of its key 200dma support over time.
Since all bull markets flow
above their 200dmas and then ebb back down to them periodically,
the best time to enter any bull market on the long side is when
it has converged with its 200dma. The HUI has already converged
with its 200dma twice in 2005, a critical technical event that
has proved immensely profitable in previous uplegs for intrepid
contrarian investors and speculators who bought near the 200dma.
Today the HUI is once again just under its 200dma, represented
by the red rHUI line now trading at less than 1.00x the HUI's
200dma. Previous sub-200dma periods where the HUI fell under
its key trailing support line are highlighted in blue. Notice
above in every previous case that the HUI started climbing
soon after it fell under its 200dma. Today is not likely to prove
any different.
Prevailing sentiment, as discussed initially above, is a direct
consequence of recent price action. Investors are generally bearish
on the HUI today since it has been weak, no other reason. Conversely
investors are usually bullish near major interim tops, when the
HUI soars more than 50% above its 200dma. Just as contrarian
theory predicts, the majority of investors are always wrong at
the turning points. They are bullish when they should be bearish
and bearish when they should be bullish.
A key example that shines light on today's probably irrationally
pessimistic HUI sentiment is March 2003. Look at the chart above
and imagine there is no data after March 2003 and you are trying
to game the index in real-time two years ago.
At that time, the HUI was struggling under 125 and popular predictions
of a sub-100 HUI abounded. Washington was about to invade Iraq
and most people thought gold had only rallied due to war
fears. So, the popular reasoning went, once the war was launched
and uncertainty evaporated gold would collapse and drag the HUI
down with it. Even most gold bulls considered you crazy to be
bullish then, as I remember well as I was writing bullish
essays at that interim bottom.
Like many of the bearish arguments today, the gold-war-rally
argument of March 2003 seemed logical and sound at the time.
Yet, regardless of how appealing it was intellectually, it overlooked
two key factors that are also being ignored today in the growing
hysteria of HUI pessimism.
The secular gold bull is driving the gold-stock bull. As long
as gold continues higher for global supply/demand reasons gold
stocks will march higher right along with it. Yes, gold will
correct periodically and weigh on gold stocks, but all corrections
in a secular bull market are temporary. Was gold in a secular
bull market in early 2003? Yes. Is it still in a secular
bull today?
Absolutely.
And if gold is in a secular bull, then its prices will
rise over time on average. And unhedged gold stocks will
rise as well as their profits
multiply due to a higher gold price. So if gold is still
rising and gold stocks are trading at their linear support, and
under their key 200dma, then there is no better time to aggressively
throw long. These very bullish technical conditions were met
in March 2003 before one of the greatest HUI uplegs in history
and they are once again met today.
The bottom line is the recent HUI correction that has spawned
so much consternation is totally normal technically and was expected
in advance. Gold remains hostage to the dollar's capricious whims
in Stage One and the dollar was simply due for one of its periodic
bear rallies to blow off some steam. And as the dollar rallied
since December gold fell and the HUI was dragged down with it.
In the midst of all this despair though, gold remains in a secular
bull. And if gold continues to rise in the years ahead, gold
stocks will follow. And if gold stocks will follow, there
is no better time to buy technically than in conditions just
like today's where HUI volume is anemic, the HUI is hovering
at its linear support, and the HUI is meandering just under its
key 200dma.
If you are wondering how we are playing this probable coming
HUI upleg, please consider subscribing to our acclaimed monthly
Zeal Intelligence
newsletter.
The latest issue, just published a week ago, outlines ten open
gold and silver stock trades that we have been layering in preparing
for the next upleg. Like the HUI all of these companies remain
technically weak today, but they are likely to thrive or even
soar along with the HUI when its next upleg erupts. We will continue
to add more trades as appropriate in future issues. Please subscribe today
and buy cheap before the HUI runs and leaves you behind!
Our subscribers also gain exclusive Web access to the same private
charts that we use to make our trading decisions, including larger
more detailed versions of the composite HUI volume chart, rGold,
rDollar, and the rHUI among many others. We update these charts
a couple times a week or so enabling our subscribers to follow
all these exciting technical developments and signals as they
transpire.
Today's widespread pessimism on the HUI is par for the course
for major interim bottoms in gold stocks, nothing new under the
sun. But if you can dig down to the core issue, gold's secular
bull, and consider the very bullish HUI technicals, then the
long-side opportunities in gold stocks today look vast.
Adam Hamilton, CPA
April 8, 2005
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
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