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April 18, 2008

Gold, Silver, HUI Technicals
by Adam Hamilton

After an exceptionally turbulent month in the precious-metals complex, many traders are trying to make sense out of all the chaos. Did the recent violent retreats in gold, silver, and the HUI gold-stock index likely mark the ends of their respective uplegs? Or do these strong uplegs probably remain intact?

Obviously this question is crucial as the prudent tactical trading strategy going forward varies radically based on its answer. If these PM uplegs have given up their ghosts, then it makes sense for traders to unload their remaining long positions and maybe even get short. But if these PM uplegs persist, then the gains to come will still be reaped on the long side.

As mere mortals, none of us can see the future. So only time will solve this conundrum with certainty. But as speculators, we have to game the probabilities now before the outcome is clear. Technical analysis, analyzing the PM price charts, is one tool that can help put all the recent volatility into perspective. Seeing a lot of trading days' results in context offers a valuable read on the odds going forward.

Often technical analysis is viewed with suspicion, like some form of superstitious divination. But it does have great merits. Charts offer perspectives on trends that are not apparent by just watching one trading day at a time. Market prices are the aggregate result of all buying and selling decisions for an asset, regardless of the motives behind them. So theoretically, charted prices reflect all available information.

But even if you still think technical analysis is like slaughtering chickens and "interpreting" the resulting bloody mess, realize that the majority of traders believe it is valid and useful. In the financial markets, often popular belief becomes reality. If a significant fraction of the capital trading any asset believes a certain chart level is important, and it enters or exits the asset accordingly, it becomes a self-fulfilling prophecy.

To make a crass analogy, if a suicide bomber kills you it really doesn't matter whether you share his faith or not. Your own beliefs are irrelevant. If he is willing to act on his beliefs in a way that affects you, then you better learn about his beliefs. Technical analysis is similar. If many market participants believe in trend lines, and their trades affect the prices of your trades, then you have to pay attention to charts.

Thus these gold, silver, and HUI technical charts offer insights valuable to all traders. They are all upleg-to-date charts, running from a month before the mid-August births of these uplegs to today. Prices, moving averages, and standard-deviation bands are tied to the right axes. Relative prices, or prices as multiples of their 200-day moving averages, are rendered in red on the left axes.

Gold drives the entire PM complex, it is the key to everything. Ultimately the gold stocks and even silver and the silver stocks follow gold in the end. They are effectively gold sentiment plays that amplify gold's own volatility. If gold heads higher, sooner or later silver and PM stocks will follow. If gold gets weaker, silver and PM stocks usually mirror this behavior right away. So we'll start with gold.

Gold bottomed in mid-August right at its 200-day moving average. Then it started surging higher in the magnificent uptrend rendered above. It remained within this trend channel, carving higher highs and higher lows, until late February. Then it started heading above its upper resistance line on its way to a new all-time high. By mid-March, gold had rallied an impressive 54% in just 7 months!

PM traders were pretty excited about this, as gold closed slightly above $1000 for the first time ever. But soon after, the metal started plunging. In just 3 trading days it lost 9.3%! It bounced at its uptrend's support line initially and rallied, but on April 1st gold plunged again. That day alone it shed 3.8%, its biggest daily loss in nearly two years. These steep retreats have wrought considerable sentiment damage.

The 3-day plunge ending March 20th drove gold under its 50dma. The precipitating event was the Fed's less-than-expected rate cut. This month's issue of our Zeal Intelligence newsletter discusses this episode in depth. And then the subsequent April 1st plunge drove gold below its uptrend support line. Together these ominous technical tidings have led many traders to conclude that this gold upleg has to be finished.

It is certainly true that gold's uptrend was broken, but not necessarily its upleg. A trend is an ever-evolving beast, a human attempt to shoehorn a price progression into a linear path. Thus trends constantly adjust as new price data streams in. An uptrend drawn 6 months into an upleg can change significantly from an uptrend drawn 3 months in. Since they are constantly in flux, broken uptrends rarely bother me.

As the silver and HUI charts below illustrate, uplegs don't need to stay in a neat uptrend. They usually don't prove so accommodating. So gold's upleg, its major bull-market move higher, can certainly remain intact even if its path higher is chaotic. Uplegs are driven by sentiment, they are born in extreme fear and die in extreme greed. And there are plenty of clues above indicating we haven't seen serious greed yet.

Leading into its high in mid-March, gold did not shoot parabolic. It only rallied 2.2% total over the 10 trading days leading to its peak. At upleg tops, greed and enthusiasm tend to wax ecstatic which drives a climaxing vertical surge. At the top of gold's last major upleg in May 2006, for example, this metal soared 13.6% across that upleg's final 10 trading days! Without similar euphoria now, a major top is pretty unlikely.

Relative gold, gold divided by its 200dma, also reflects this lack of upleg-ending euphoria. Note above that gold only hit 1.296x its 200dma in mid-March. This isn't much higher than the 1.273x seen in late January or the 1.222x seen in early November. At its May 2006 top, gold soared to 1.389x its 200dma. And much higher levels (up to 1.670x) were seen in the last Stage Two uplegs of the 1970s.

Without similar stretches over its 200dma today to reflect widespread greed, the odds that this latest Stage Two (driven by global investment demand) upleg is over are not high. At +54% so far, it is even still modest by Stage Two standards. We saw +108% and +94% uplegs at this stage in the 1970s bull, and the upleg that ended in May 2006 ultimately witnessed gains exceeding 73%! Today's upleg isn't anywhere close yet.

But if the sharp retreat over the past month is not an upleg-ending correction, then what else could it be? A mid-upleg pullback. Periodically during in-progress uplegs, greed gets a bit excessive but nowhere near upleg-ending levels. So a sentiment rebalance is necessary. This can happen via a high consolidation like that witnessed in gold last November and December. Or it can be via a sharp pullback to scare traders.

For all the sound and fury of gold's plunge, it merely hit a 49-day low in early April. As recently as January, this gold pullback low had never before been witnessed in history. So it is not like gold ever got low despite its sharp pullback. It could simply be consolidating high to build a base for its next surge in this upleg. In late November analysts swore gold was correcting too, but look at its surge since then!

Another interesting gold technical is its 200dma. In its entire 293% run higher since April 2001, gold has never spent much time under its 200dma. In fact, anytime gold is driven under its 200dma due to excessive fear it quickly rebounds back. In any ongoing secular bull, the 200dma forms some of the most important support. Today gold's 200dma is already above $800 and still continues to rise.

So as long as gold consolidates high, its 200dma is catching up with its price. Since this 200dma is the most likely sustained downside target even in a full-blown upleg-ending correction, gold's downside risk from here seems minimal compared to its upside potential. All kinds of factors remain very bullish for gold, from exploding inflationary expectations to massively negative real interest rates in the US.

So yes, gold did break its uptrend earlier this month. But this does not necessarily mean its upleg is failing too. Trends evolve along with uplegs, constantly changing. And sharp extra-trend moves like the spike lower in early April can certainly happen from time to time. Despite all the angst it caused, there is still plenty of technical evidence suggesting we probably haven't seen the top of this particular gold upleg yet.

Silver's upleg, as usual, has been more extreme than gold's. It was up over 80% at best as of early March, quite a gain for a relatively short 7-month timespan! Silver's behavior is very interesting as it is illustrative of the kind of chaos seen within uplegs that doesn't necessarily portend their ends. Silver's consolidation lower in November and December nicely demonstrates these technical principles.

Silver wasn't looking good technically then. It was grinding lower in a new downtrend, carving lower highs and lower lows during November. By mid-December, silver had fallen under both its 50dma and its major uptrend support line. The technical damage was considerable so many silver analysts were calling for a sharp correction. This reminds me a lot of how gold's 50dma and support breaks are perceived today.

Yet was silver's upleg over in mid-December because it was beaten up technically? Hardly! The metal soon started surging out of those irrational fears from under $14 to nearly $21! While silver does ultimately follow gold's lead and gold happened to head higher then, this is still an interesting episode. Technical breakdowns in an ongoing upleg don't necessarily mean it is over. They happen periodically mid-upleg.

Silver was climbing nicely, at a sustainable pace, until late February. Once it went over $18 though, speculators started flooding in. The surge of buying interest made it shoot parabolic in a vertical ascent. Such sharp moves are seldom sustainable, but silver tried hard to hold its gains. In early March it consolidated high near $20, reflecting the high gold prices, rather than collapsing under its own technical weight.

But when gold plunged on the Fed decision in mid-March, silver plummeted in sympathy. There was a lot more greed in silver then, a lot more new speculators who had bought in high, compared to gold. And they sold with a vengeance. Silver fell 16.9% in 3 days and sliced through its 50dma like a hot knife through butter. As always, this 50dma failure made traders really nervous. Was silver's upleg over?

While 50dmas are generally good support within ongoing uplegs, this isn't always the case as December illustrated. Sometimes short-term fear-driven events can rip through these lines. But as long as bullish fundamentals remain intact, and sentiment didn't get too greedy prior to the pullback, the upleg can still continue higher. So far, this certainly looks like the case with silver.

While its 50dma failed in March, its uptrend support held. At worst, it merely fell to a 37 trading-day low. The $17 to $18 range where silver has been consolidating since is still quite high. These levels haven't been witnessed since the early 1980s and they are very impressive. Back in December when silver was struggling in the $14s traders wouldn't have believed that a sharp pullback down to $17 would scare them!

While silver did shoot parabolic unlike gold, it didn't go parabolic enough to mark the probable end of an upleg. In its 10 trading days prior to its March peak, silver rallied 16.8%. This compares to 19.8% in the final 10 days of its upleg ending in May 2006. And silver only hit 1.465x its 200dma in March 2008, compared to 1.651x in May 2006 and 1.704x in April 2006. By silver's wild standards, we didn't just see typical upleg-ending levels of euphoria. It isn't known as "the restless metal" for nothing.

At any rate, silver will ultimately follow gold's lead. So if gold's upleg is over, silver's is too. But since I really doubt the former, the latter is unlikely as well. Silver started to see some greed in late February and grew short-term overbought. When gold retreated on the Fed, silver seized the excuse to vent some greed and it plummeted sharply. But it still remains very high relative to this upleg and certainly to its bull to date.

I really don't think gold and silver are the problem for most traders. Anyone who has been watching these precious metals for longer than three months has to be impressed with their prices today even post-pullbacks. The real source of irritation is the PM stocks. Never a sector for the faint of heart, its recent extreme volatility has really tested traders' resolves. In March the HUI plummeted 16.5% in 5 trading days!

This sharp plunge easily knifed through the index's 50dma and through the line most traders were viewing as support. There is no doubt it was an ugly selloff. But as with gold and silver, the HUI technicals aren't quite as bearish as they might appear at first glance. This is a high-risk high-potential sector and extreme volatility is par for the course. I recently explored the HUI's probabilities of seeing big daily moves.

Starting back in August, the HUI surged sharply off of those irrational lows. This happened to be the best early massive upleg of this bull and spawned very high expectations for continuing fast gains. But the HUI's ascent soon moderated and marched higher in the uptrend rendered above. Its first major support line that PM-stock traders were following is labeled as "midline" above. This held for several months.

But after surging into early November to an all-time high, the HUI retreated sharply. This pullback bounced at the support at the time and looked fine, although widespread calls for a major correction remained. By mid-December, fear seized PM-stock traders' hearts and they sold gold and silver stocks aggressively. This ugly fear-driven anomaly drove the HUI well under both its 50dma and support at the time.

But not only is no emotional extreme ever sustainable, ultimately the HUI follows gold. When gold started rallying again in mid-December after its high consolidation, gold stocks surged to catch up. Soon the HUI was back above both its 50dma and prevailing support. It went on to hit new all-time highs in January, February, and March. The key point here is technical failures don't have to kill in-progress uplegs.

Actually the HUI had already pulled back sharply from its upper resistance line twice before the latest such episode in mid-March. Sharp pullbacks from resistance are not at all uncommon in uplegs. After trading this gold-stock bull since its birth over 7 years ago, I have seen more sharp pullbacks during in-progress uplegs than I can count. March's pullback may have been abnormally fast, but it wasn't abnormally deep.

Provocatively, this March pullback ultimately took the HUI to a point parallel with its December low. This is making me suspect that support is really at the lower support line in this chart, not the higher midline traders have been watching. Remember that trend channels are constantly in flux and their slopes and widths often change over time. If this lower support line is indeed valid, then the HUI never left its uptrend channel!

And like gold and silver, the HUI's interim high in March didn't look like historical upleg-ending tops. It only rallied 5.9% over its final 10 days, no euphoria was seen. The relative HUI only traded up to 1.302x this index's 200dma. And this was also about as high as the HUI got relative to its 200dma in both early January and early November. Historically in massive uplegs in this bull, the HUI has always stretched more than 1.50x above its 200dma before they ended.

And while the HUI's 71%+ gain since mid-August was nice, it was small relative to bull precedent. The average gain of all 7 HUI uplegs in this bull before our current one is +94%. And the average HUI gain in its massive uplegs, every other upleg when it hits new highs, is a whopping +136%! And with gold looking very comfortable in the $900s, it is hard to imagine this PM-stock upleg not proving massive.

So technically, the HUI certainly didn't look like it hit a major upleg top in mid-March. Nor did its characteristic sharp pullback from resistance to support look like a post-upleg correction. Technically it merely looked like a sharp mid-upleg pullback. The HUI never left its uptrend channel if the new lower support line above proves valid. And mid-upleg 50dma failures in this index are not uncommon at all.

In light of these gold, silver, and HUI technicals, the evidence seems to support a couple key theses. First, none of these metrics became euphoric enough by their own bull-to-date standards to suggest major upleg-ending tops. There was no universal extreme greed driving the PM complex as a whole vertical. And without these kinds of technical signs evident at major upleg tops, the odds favor the subsequent carnage merely being sentiment-rebalancing mid-upleg pullbacks.

And sharp pullbacks can easily pierce technical lines traders hold dear, like 50dmas and current uptrends' support. Yet as long as pre-retreat sentiment wasn't too greedy and the underlying fundamental drivers of the upleg remain intact, it won't end regardless of short-term technical damage. In precious metals, extreme volatility within uplegs is just an expected part of the game.

If you enjoy this kind of technical analysis, I do a lot of it in our monthly Zeal Intelligence newsletter and especially our weekly Zeal Speculator alert service. We maintain extensive custom charts on our website exclusively for our subscribers as well. Today we continue to add trades in elite gold and silver stocks since these precious-metals uplegs look intact. Subscribe today and join us in the probable run higher!

The bottom line is all uplegs can be chaotic, especially in the volatile precious metals. As any upleg evolves, its best-fit technical uptrend channel is constantly adjusting to reflect all the latest price information. Thus mid-upleg failures of uptrend support lines and even 50-day moving averages is not uncommon. From time to time excessive fear can spawn sharp mid-upleg pullbacks.

So to this point, nothing technically alarming has happened in gold, silver, and the HUI. Sure they fell sharply, and it was a quick plunge, but it was from above resistance to down near or under support. Prior to these sharp pullbacks, neither gold, silver, nor the HUI exhibited technical behavior like that seen in their own respective past major upleg tops within their bulls. So odds are these uplegs remain intact.

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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