Markets all around the world are rallying with the Dow Jones putting on over 25% since the March lows and the Australian All Ordinaries index rallying 20%. Market experts explain how the stock market is a barometer for the future and the signs are there that we are starting to turn the corner economically. Meanwhile, the economic news remains grim with few signs that a recovery is imminent. The underlying point of importance here is decades of economic mismanagement and neglect do not get reversed in the space of a handful of months and regrettably saying it doesn’t make it so.

Volatility is not something the average investor tends to stomach easily. I believe it is one of the primary reasons why only perhaps 1 out of every 100 investors own precious metals related investments, despite a strong performance in recent years. The advent of the ETF has, if anything, added to this volatility. With the click of a mouse, investors can buy and sell a claim on the metal at the drop of a hat.

With markets rallying, there are many investors buying into this recovery story and the ones that are sitting on the sidelines are sweating bullets. This is especially the case for retirees who have significant losses to recover and had perhaps pulled their money out in fear of worse to come. The temptation to redeploy the funds and let the chips fall where they may is palpable. The fundamentals look woeful but the market is rising?

Volatility and a short term investment mentality is a recipe for disaster when investing. It is what leads many of the few western precious metals investors to buy and sell at precisely the wrong time. This invariably leads to ordinary results, turning many off the sector entirely. The more volatile the sector, the harder it is mentally to invest in. This is especially the case if you have insufficient knowledge of what you are investing in and why

Like it or not, investors are going to have to become more comfortable with volatility in the future. People are now throwing money back into the market for no other reason than it is rising. It won’t take much for that money to exit as conviction is clearly a notable absentee. The good news for the precious metals sector is that the investment public will slowly grow more tolerant of volatility. Volatility over time will become less of a deterrent with strong fundamentals and outperformance playing more of a crucial role. Market participants are also learning that having knowledge in the sectors they invest in is critical. Volatility and a lack of conviction almost guarantee losses over the long term. There are very few sectors which will teach you this lesson more effectively than the precious metals sector. Something I have learned from experience I can assure you!

Gold Wave Analysis Update

(Click on images to enlarge)

Commentary

The gold price has continued to demonstrate weakness over the last month and has momentarily broken US$900/oz and is finding reasonable support in the US$875 – US$890/oz zone. The next clear support level is around the US$850/oz mark. Much of the weakness in the gold price can be attributed to the “temporary” upswing in market confidence. The gold price and the gold shares for that matter have remained fairly resilient in my opinion. The pattern gold is making resembles a classic Reverse Head and Shoulder, which is the most bullish of consolidation patterns. At the present time, the neckline sits at about US$990/oz. The right shoulder is presently being formed which could see gold dip to support at US$850, before completing the bullish formation with a strong rally higher. The way the gold shares are behaving very much supports what we are seeing, as they have remained relatively strong despite the falling gold price. See the XAU and API commentary below for more detail. I remain comfortable that this is a temporary correction within our longer term stage 3 rally higher.

XAU

The chart below highlights key points in time when the XAU is overbought (RSI 30) and oversold (RSI 70), relative to gold. Once the respective indicators trigger (blue vertical lines), it then becomes a task of following trends in the ratio looking for definitive breaks to signify entry (green vertical lines) and exit (red vertical lines) points. The gold price wave analysis above helps us get our bearings. Right now, with the commencement of a Wave 3 rally, we should expect to see precious metals equities outperform the gold price signaling further strength in the metal.

Gold/XAU Long term Picture

Gold XAU Ratio

Gold/XAU Intermediate Term

Commentary

The Gold/XAU ratio, after briefly breaking the support at 6.95, continues to consolidate around the 7 mark. A look at the XAU chart itself (middle section) shows a very solid triangle consolidation pattern with resistance at 138. A clear break through 138 would signal the commencement of a strong rally. Over the next few weeks it will be interesting to follow the Gold/XAU ratio, especially if the gold price does in fact fall down towards US$850. If the gold shares continue to outperform during this time and hold say 7.50 - 8.00, I would be taking this as a bullish signal that the fall will be short term in nature and not the start of something more prolonged. On the other hand, if the gold shares underperform and we break 8 on the Gold/XAU ratio, we may be looking at something more drawn out.

Closing Comments

The gold price has corrected over the last month but still looks technically sound. The fundamentals are as good as they have ever been, which should give investors the conviction to see past any short term volatility. If you are finding yourself falling into the temptation of having a look at the beaten banking and industrial sectors given their impressive rebound, I would urge you to think carefully. The rules of engagement in the present market are quite simple. Invest your money in the asset classes and companies that make fundamental sense despite the global recession. Get a solid grounding of the fundamentals. You will find these investments will be the only ones you will feel compelled to hold and add to during times of increasing volatility and the associated spin that comes with it.

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