 HUI
Tests Support
Adam Hamilton
Archives
June 11, 2004
In light of the latest gold-stock
weakness earlier this week, once again precious-metals investors
and speculators are nervously watching gold and silver and the
companies that mine them.
Just as at any apparent inflection
point in the financial markets, bullish and bearish theories
on the precious-metals markets abound. Some folks believe we
are heading lower, others believe we are heading higher, and
still others are betting on a new trading range developing.
As usual, compelling arguments
exist advocating all three possible outcomes. These competing
opinions are very healthy and keep the markets exciting to study
and trade. If the vast majority of players were either bullish
or bearish, then the probabilities of a major move in the opposite
direction contrary to consensus would be high. But when popular
sentiment is fractured and fragmented as it is today, the risk
of large moves is fairly low. This type of uncertain environment
is ideal for technical analysis.
While sharp daily plunges like
Wednesday's 5% drop in the flagship HUI unhedged gold-stock index
are certainly psychologically grating for PM bulls, I still find
myself firmly entrenched in the bullish camp. Not only do the
rock-solid fundamental foundations of this metals bull remain
intact, but the technical chart picture is also encouraging as
the HUI tests its major support zones.
Of course the fortunes of the
HUI are directly tied to those of gold. As goes gold, so goes
the HUI. As such, the strong fundamental case for the Ancient
Metal of Kings itself directly transfers right through to the
ultimate leveraged proxies on the metal, the unhedged gold stocks.
If gold is destined to march higher in the months ahead, then
so will the HUI. It is gold that drives the HUI, definitely not
the other way around!
The bullish fundamental case
for gold is well-traveled ground. Most importantly, annual global
demand exceeds mined supply, and since new mines take years to
bring online this structural deficit is likely to persist for
many years into the future yet. And this is certainly not the
only part of gold's bullish outlook.
Real interest rates remain
negative, the ideal monetary environment to spawn a gold
superbull. Unbridled monetary growth in the First World is also
leading to a surge in inflation,
relatively more money chasing after relatively fewer goods and
services. This is already painfully evident in crude
oil along with other key necessities of life.
On top of all this gold continues
to shine as pretty much the only relatively safe alternative
investment today. The US equity markets remain terribly
overvalued by all historical standards and destined for a
mean reversion back down through fair value, under 14x earnings.
Residential real estate and the bond markets are in serious trouble
as soon as the Fed starts raising interest rates in the weeks
ahead. Even the mighty US dollar, gold's arch nemesis, still
appears to be topping after an expected major bear-market
rally.
But even with gold's strategic
fundamentals remaining extremely favorable, it is often hard
to keep them in sight during periods of short-term weakness.
On days when gold falls and your own PM stocks are threatening
to trigger their stop losses, bearish analysis and opinion seems
to drown out everything else.
We all have a natural human
tendency to pay more attention to information on a daily basis
that tends to explain that particular day's trading activity.
If the HUI is up we look for bullish supporting info to rationalize
it, and if it is down we listen to the bears. Being in the newsletter
business, I am all too aware of this innate propensity as it
has a direct impact on newsletter sales!
Whenever I write an essay advocating
a particular market view that I expect to unfold over a few
months or a few
years into the future, newsletter sales are far more dependent
on the markets' behavior immediately on publishing day as opposed
to whether or not I was right over my stated time horizon. So,
if gold happens to be up the day this essay is published, we
will sell far more newsletters than if gold was down on that
particular day. This observation provides a crucial insight into
speculator psychology.
Daily market price performance
drives popular sentiment, which in turn seeks information that
tends to support and explain the most recent daily price movements.
The danger in succumbing to this short-sighted behavior is that
it can easily lead to a circular reasoning cycle that traps a
speculator.
Allowing oneself to be tossed
to and fro emotionally based on daily psychology leads to a chronically
short-termed focus, poor decisions, and ultimately unbearable
psychological stress from being in the markets. And these bad
habits render one even more vulnerable to the fickle daily swings
in herd psychology which help accelerate a further downward spiral.
How do we overcome this natural
tendency to focus too heavily on just the price behavior of the
past few days or so alone? First, it is crucial to keep the broad
strategic fundamental picture in mind at all times, especially
during countertrend moves such as the HUI's pullback. Second,
make sure you always view current daily activity within the context
of longer time horizons. This is where technical analysis and
charts shine brilliantly.
The HUI weakness earlier this
week which spawned so much angst in the gold community was not
at all fearsome or even impressive within the proper context
of multi-month and multi-year price charts. Both short-term and
long-term HUI charts are presented below, along with a technical
interpretation from both perspectives.
An investor or speculator who
always remembers to view daily action within the context of longer-term
trends on charts is far less likely to be swept away in the capricious
popular day-to-day market psychology. In a very real sense, studying
the markets from a technical perspective helps steel oneself
from the rapidly shifting sands of prevailing emotions.
Wednesday's 5% plunge in the
HUI is the last day of data on this chart. 5% is a big daily
number and sounds ominous, but when viewed within this short-term
technical context it does not seem outrageous or threatening
at all. We can even add in Tuesday's 2% drop as well to consider
the HUI's total 7% fall in only two trading days this week. Interestingly
though, a careful examination of this chart reveals even larger
consecutive daily losing streaks in the recent months.
In December, the HUI fell 9.9%
in three days. In January it fell 12.0% over four days. In February
it fell 10.3% in four days. We were granted a welcome little
breather in March, with no significant daily losing streaks.
The real carnage erupted in April though, which witnessed three
sharp declines of 9.9% over four days, 8.5% over three days,
and 9.5% over two days. There was yet another final HUI plunge
in May, 10.7% over three days.
In only six months we have
already seen no less than seven consecutive daily losing streaks
that were worse than what we witnessed this week in the HUI.
So in terms of raw probabilities, the two-day 7% decline in the
flagship gold-stock index this week was not at all uncommon and
actually rather anemic for a pullback. On this chart you can
easily see visually how this latest slide looks much smaller
than those of recent months. So while a 7% drop over two days
seems ominous when considered in isolation, in the context of
the HUI's chart it is hardly even worth noticing.
Who so much HUI weakness in
recent months? It is not because the bull market in gold has
ended, as it almost certainly has not based on fundamentals,
but because the PM stocks were simply overbought in early December.
At the time the HUI was soaring leading to far too positive sentiment.
Anytime that the majority of popular opinion within a market
community lines up on only one side of a trade, odds are a contrary
move is imminent. And that is just what happened in the HUI.
The multi-month correction/consolidation
in the HUI since December that is responsible for all these consecutive
daily losing streaks was not a surprise. I wrote about the high
probability for a coming correction in early December in "Trading
the Gold-Stock Bull 3" and again in early January in
"The
Relative Dollar and Gold." Gold and the gold stocks
had simply run up too far into overbought territory and just
needed to correct. No big deal.
Like all countertrend corrections
running against a primary trend though, this HUI correction had
to end somewhere. I believe it hit that point in early May following
a brutal capitulation in April. The HUI entered a sickening waterfall
decline as selling intensified and fed on itself. These relentlessly
falling prices naturally drove psychology within the gold community
terribly negative, deep into fear-laden oversold territory. When
everyone wanted to sell after a blistering 29% slide, the seeds
of the V-bounce were born.
The HUI's V-bounce of early
May is crystal clear in this graph. It went from massively oversold
hugging its lower Bollinger Band to soaring back up to its 50-day
moving average before regrouping. The 50dma, as is evident above,
tends to act as either support or resistance for gold stocks.
Coming up from below in this case, the 50dma was seen as a potential
resistance zone by the markets so traders sold the HUI in recent
weeks when it was challenging this resistance.
Encouragingly, even this week's
7% plunge in the HUI really didn't take it into dangerous territory
technically. The HUI ended up just below its short-term linear
support line that has held for most of its consolidation/correction
since early December. It is not at all uncommon for old support
to temporarily turn into short-term resistance and almost magnetically
attract prices trying to break back above. We could certainly
see the HUI flirt around this old support line a bit more yet
before it starts marching higher again.
Thus, technically we have an
expected HUI correction that began in December with a consolidation
gradually grinding lower. After four consecutive lower interim
highs by early April, fear finally kicked in and the consolidation
turned into a full-blown correction that ended in a waterfall
decline that is a typical of the psychological capitulation marking
bottoms. Since early May, the HUI has rebounded sharply before
pulling back modestly to retrace, which brings us to this week.
As the capitulation ended in
May, the HUI closed at 168.80, which felt pretty darned low at
the time. This Wednesday, the last day of data in these charts,
the HUI closed at 183.18. This latest interim low is already
8.5% higher than the May V-bounce. And technically what do a
series of higher lows mean? An uptrend! This chart looks like
the HUI is in the early stages of developing its next major upleg.
This is really exciting for gold investors and speculators as
the last few major uplegs of this gold bull have been fantastically
rewarding!
Even from a short-term technical
perspective, this week's HUI weakness does not look at all frightening
and makes perfect sense within context. Whenever any financial
instrument that you are tracking or trading makes a large daily
move that threatens to unleash your deadly emotions of greed
or fear, it is best to immediately grab a chart of at least six
months in duration to see where the latest daily swing fits in
context.
These charts go a long way
towards short-circuiting deadly emotions and shifting the emphasis
back away from day-to-day action to the multi-month trends that
really matter for investors and speculators. And, not surprisingly,
the broader the context in which you view a particular day's
trading action, the less important it becomes. This long-term
HUI chart remains fantastically bullish even in light of all
the correction weakness since December!
Any secular bull market, including
this one in the HUI, tends to flow and ebb, usually surging higher
with its primary trend but sometimes correcting back down in
countertrend moves to eliminate temporarily overbought conditions.
In long-term context the past week's weakness as well as the
entire correction since December looks totally healthy, a necessary
ebbing back down to major support.
Over its entire bull to date,
the HUI has generally surged higher from two primary support
lines, its key 200-day moving average, drawn in black above,
and its simple linear support, the dotted blue line. Back in
early December I figured the HUI would probably correct to its
200dma and bet accordingly. In late 2001, mid and late 2002,
and early 2003 the HUI's 200dma had held pretty solid as major
support and marked the bottoms of the periodic corrections in
the index.
While I was thankfully proven
right on the correction, I underestimated its magnitude. The
HUI did correct back down to where its 200dma was in early December
at its latest interim top, 165 or so, but since the correction
consolidated for so long before plunging the HUI ended up falling
far below its 200dma in real-time.
The red line in these graphs,
the Relative
HUI, quantifies the distance away from its 200dma that the
HUI has been traveling in its bull to date. For example an rHUI
reading of 1.00 indicates the HUI was trading at its 200dma,
while 1.10 shows it 10% higher than its 200dma.
This rHUI line has formed a
beautiful series of waves as this bull market unfolded. In each
of the last three years, the HUI surged far above its 200dma
stretching the rHUI much higher. But following each of these
major and hugely profitable uplegs popular sentiment within the
gold community was waxing too bullish so a correction was necessary
to weed out short-term speculative excesses. The rHUI waves above
really do a superb job of quantifying these sentiment waves that
gradually push a bull higher.
Unfortunately the 200dma failed
to hold as support this time around though so the rHUI just fell
to its lowest levels in this bull to date. This spooked a lot
of folks, and I certainly wasn't very happy about it myself in
early May. But, provocatively, after rapidly knifing through
its 200dma the HUI fell down to its next major logical support
level and then bounced. This is the linear blue support line
drawn above, the most basic of all technical analysis tools.
As you can see, linear support
approaches have marked every major interim bottom in unhedged
gold stocks since 2001. Our 2004 bounce along this old support
line is extremely encouraging for technical-psychology reasons.
Since every technical analyst on the planet with a straight-edge
and a HUI graph can easily draw this linear support line, its
getting hit again is a huge deal. When the HUI approached its
old linear support zone, countless technical buy signals around
the world fired which no doubt contributed to its sharp V-bounce
last month.
With the HUI still near its
linear support, most technical analysts considering this strategic
view remain very bullish since the HUI's primary bull-market
uptrend remains intact. And technical analysis ultimately drives
trading decisions, either directly or indirectly, for the majority
of the world's investors and speculators. A linear support bounce
at the most foundational support line of the entire primary bull
in the HUI is probably the ultimate technical buy signal!
This longer-term view also
yields a fascinating fractal comparison. Fractals are a mathematical
term used to describe geometric structures that have the same
basic shape at different scales. The markets really tend to be
fractal in nature too, with similar price patterns occurring
on charts whether they encompass any range from only a day to
several decades. The major gold-stock uplegs of early 2002 and
late 2003 look remarkably similar above, very comparable shapes
at different scales, like fractals.
Both the 2002 and 2003 HUI
uplegs embarked from their linear support, marched relentlessly
higher for at least a couple quarters, hit a dazzling new high,
consolidated in a moderate downtrend, and then plunged in a final
capitulation panic before bouncing off of their major support
again. I think the correction stage of our latest gold upleg
in early 2004 closely matches the behavior of the correction
stage in the middle of 2002. If you compare these two patterns
they are remarkably similar.
The 2003 gold upleg ultimately
witnessed a massive HUI gain of 124.6% from March to December
of last year. The 2002 gold upleg blasted up by 145.4% from November
2001 to June 2002. If May's capitulation lows really prove to
be the bottom of our recent correction, then the HUI sold off
by 34.3% from December to May. Back in 2002 that older consolidation/correction/capitulation
ultimately dragged the HUI down by 35.7% from early June to late
July.
Thus, not only does the pattern
of our recent upleg and correction match 2002's example, but
the upleg magnitude is similar and the correction distance from
the respective interim highs is virtually exactly the same! The
events we have just witnessed in 2004 look remarkably similar
to those of mid-2002, which proved to be very bullish after the
HUI bounced along its same major linear support line that it
just hit again in early May.
These fractal uplegs illustrate
the timing of the popular psychology waves flowing under the
surface, from bullish to ecstatic to bearish to panic-stricken
and back to bullish again. This progression is all part of the
natural bull-market cycle. Bull markets flow and ebb, taking
two steps forward and then one step back. The charts clearly
illustrate this phenomenon.
Coming full circle, the best
way to ensure that the inevitable daily sentiment swings don't
seduce you into making emotional trading decisions is to focus
on the fundamentals as well as technicals within their short-term
and long-term context. On the charts neither the sharp pullback
in April nor the down days earlier this week look at all strange
or threatening. Actually the V-bounce looks like the birth of
a major new upleg in the HUI!
Day to day all kinds of funny
things can happen in gold stocks, which tend to closely follow
the price of gold. If the US dollar rallies gold is usually hit,
and when gold drops so does the HUI. Conversely when the dollar
slumps and gold gets a bid, the HUI tends to blast higher as
well. While these short-term forces often seem random and frustrating,
they never trump fundamentals over the long term.
If you are interested in speculating
in precious-metals stocks, by analyzing the markets, stalking
opportune moments to trade, and then jumping into specific researched
elite gold and silver miners that have phenomenal appreciation
potential in this metals bull, please consider subscribing
to our acclaimed monthly Zeal
Intelligence newsletter today.
In it I discuss current market
developments within the crucial overarching strategic context
of fundamentals and wider technicals. This broad perspective
can help keep you emotionally neutral and ready and able to make
excellent trading decisions when great opportunities arise.
The bottom line is the HUI
has just been testing its support in the last month or so and
the recent weakness is probably nothing to fear. Within the context
of the secular bull market in gold stocks their behavior so far
this year makes perfect sense and mirrors past major buying opportunities
incredibly well.
June 11, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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