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July 30, 2004

Euro Gold Stealth Bull
by Adam Hamilton

While the relentless gold bull market in US dollar terms continues to help American contrarians grow wealthy, this same gold story looks very different when viewed from outside of the States.

Gold's performance in other major currencies in recent years has lagged that of dollar gold dramatically. In fact, the vast majority of foreign investors I talk with these days still tend to view our American gold bull as little more than a dollar bear.

Since gold is the ultimate form of money, it directly competes with all the fiat-paper currencies dominating the world today. The price of gold denominated in any particular fiat currency, including the US dollar, is actually the current gold exchange rate with that currency. As the US dollar bear of recent years accelerated, the dollar/gold exchange rate has naturally surged higher.

Now this resulting higher dollar/gold exchange rate, or gold price, has been a windfall for American contrarians. Bull-to-date dollar gold is up about 66% since April 2001, while the unhedged HUI gold-stock index has rocketed up by 614% so far! Whether you are an American or not, you can certainly understand why we are so excited about this gold bull in the States.

But from a non-dollar-centric perspective, gold's performance has been fairly lackluster in recent years. Since the US dollar has continued to dominate world trade throughout this gold-bull period, the dollar weakness has translated directly into local strength for major competing currencies like the euro and yen. Thus the gains in other currencies have effectively offset most of the gains in dollar gold in local terms for foreign investors.

This phenomenon is largely due to the peculiar idiosyncrasies of having a world gold market almost exclusively denominated in dollars. Gold is bought and sold in every local currency in the world, but these local prices depend heavily on the local/dollar exchange rate and the dollar/gold exchange rate. I realize that eyes start to glaze over whenever exchange rates rear their ugly heads, so this is best understood with an example.

Imagine you had been traveling in Europe in late 2001, and you wanted to pick up a European-minted one-ounce gold coin as a cool souvenir. At the time gold was trading around US$275 in the States. It was also a great time for Americans to head to Europe as the new euro was struggling. It only took US$0.90 or so back then to purchase a euro. In euro gold terms, you would have been quoted a gold price in Europe near €305 an ounce.

So to buy your gold coin, you would first have to purchase the 305 euros. At $0.90 each, they would cost US$275. So your effective price for your European gold coin would have run about $275 in late 2001, not too far from the US dollar price in New York. While small fluctuations of a couple percent around this dollar gold price are common in local-currency terms around the world, they always eventually revert back to the dollar gold price expressed in the local currency via the local/dollar exchange rate.

Now imagine you are heading back to Europe today, and would like another beautiful European gold coin for your collection. If you meander into a local coin shop you will be quoted a euro gold price around €325 these days, only 7% higher than 3 years ago. But in these intervening few years, the dollar has plunged against the euro and all other non-pegged currencies. Today it takes a whopping US$1.25 or so to buy each euro, so they cost 39% more from an American perspective due to the dollar's relentless decline.

If you buy the necessary 325 euros in order to purchase your coin, they will cost you US$406 or so. Not surprisingly, this gold price is not far away from the current dollar gold price in the States. While gold rallied dramatically in the US in recent years, in other currencies it has not. The greatest gold bull in the world today has only impressively manifested itself in the States and in countries that peg their local currencies to the US dollar.

I realize that you currency-savvy European investors read this example and can't believe I am wasting paragraphs on it, but for Americans born and raised in a dollar world this crucial concept can be elusive to grasp. It is very challenging for us Americans to think in non-dollar terms since that is all we have ever known. We Americans have to realize this crucial gold-bull fact...

Gold is up in the US in recent years primarily because of the US dollar bear. Just as the euro rises when the dollar weakens, so has the ultimate currency known as gold also marched higher.

From a European investor's perspective, this gold bull we rave about in the US is little more than a bear market in the US dollar that caused the dollar/gold and dollar/euro exchange rates to rise, nothing more. Thus, it is not surprising that non-American investors generally tend to be dismissive of this gold bull. This is totally understandable of course. Imagine how little we Americans would care about this gold bull if it were only happening in China, for example, while our own local dollar-gold price remained flat.

Interestingly however, even though foreign investors remain largely indifferent there is a subtle stealth bull in gold already underway in other major currencies! Major support lines with modest uptrends are being gradually formed in local gold markets around the world with each passing day's new data. A series of higher lows is the single most important technical ingredient for bull markets.

In this essay we are using the euro as a proxy for other major currencies, since it is currently the currency most likely to continue eroding the dollar's long-standing hegemony in international trade. As you digest these charts, realize that gold in most other local currencies, as long as they are not pegged to the US dollar, would have similar technical trends.

The subtle rising action shown in these euro-gold charts is very exciting as it may mark the early years of a true currency-transcendent global gold bull. The implications of this development are enormous for all investors worldwide, regardless of which country you consider home.

Now if our current gold bull was exclusively a dollar phenomenon, then gold in other currency terms ought to be dead flat. Yet, as you can see above the lower support lines for euro gold are moving higher. Gold in euros, and indeed gold in most other currencies, is methodically carving a series of higher lows that looks like the early stages of a major bull market!

The first support line to consider is the blue one, that of euro gold itself. It already has several intercept episodes over many years, so it is rock solid. In addition it has never been decisively broken to this point in time. While euro gold sure isn't up 66% bull to date like dollar gold yet, it does have a modest uptrend reminiscent of a stealth bull market.

Originally around €275 in early 2001, the primary long-term euro-gold support line is almost up to €325 these days. This is a non-trivial 18% gain that is well outside of the probability of being random. Gold is slowly yet relentlessly marching higher in euro and other currency terms even though most of its US action has been due to the dollar bear market.

A second support line is drawn above in black for euro gold's crucial 200-day moving average. This long-term trend line also has a modest upslope. 200dmas are very important as they usually run dead parallel with the primary trend of any price data. The fact that euro gold's 200dma is also meandering higher over years confirms that this is a real long-term uptrend and not some short-term technical aberration. The rock-solid 200dmas are completely oblivious to short-term noise and filter it all out to reveal true trends.

These technical uptrends, bull-market signatures, drive stakes through the heart of the common foreign notion that this gold bull is exclusively a dollar-bear phenomenon. Yes, it is mostly a dollar-bear thing thus far, but the dollar's weakness simply cannot account for all of the dollar-gold gains. While the American gold bull is up 66% bull to date, the US dollar bear is "only" down 30% in its own bear to date so far in US Dollar Index terms.

The US Dollar Index is a basket of currencies though, while these charts only show the dollar/euro exchange rates. In pure dollar/euro terms, the euro has risen 53% in its bull to date against the US dollar, from each euro costing less than US$0.84 in July 2001 to costing over US$1.28 in February 2004. Thus, the dollar/euro exchange rate could be considered directly responsible for 4/5ths of dollar gold's action, but that intriguingly leaves 1/5th that is not directly explainable by the dollar's secular bear.

Before we get into this 1/5th of the gold bull that has already transcended mere currency issues, there is one more technical observation I would like to point out. A lot of technicians see the top resistance line of euro gold remaining extremely oppressive at €350 and because it is straight assume that euro gold is flatlined. For a variety of reasons however, it is not usually productive to measure any bull market exclusively by its seeming inability to break above old interim highs at the moment.

For example, in November 1980 the CRB Commodities Index hit an all-time high just under 335. That stellar high has yet to be exceeded even to this day. If we were to draw a top resistance line on the CRB chart, it would start at 335 and descend in a bearish fashion. If we considered this heavy top resistance line alone in isolation it would be really easy to assume that commodities were a poor investment in the 25 years since.

But, in reality, there have been about five separate multi-year bull markets in commodities since 1980 that have each earned fortunes for astute speculators! The inability to break above an old high does not necessarily condemn an investment to the parched sands of eternal bear-market exile. While euro gold hasn't broken above €350 yet, it is in a definite uptrend and profits are being earned by buying it whenever it is near its lower support line like today.

Back to the part of this gold bull unexplainable by mere currency issues, I am really excited about this insight as I think we are witnessing the early signs of a renaissance in true global investment demand for gold. Great Bulls in gold are never driven by normal industrial demand, but by new marginal investment demand. When investors aren't interested in gold there is nothing that can make it materially rise, but when investors grow interested in gold there is nothing that can hold it back. Not even the scourge of central banks.

Every gold bull in modern history consists of two or three stages. In the first stage, gold rises merely because other currencies fall (often due to excessive fiat inflation) and hence its exchange rate goes up. I believe we are nearing the end of the first stage in our current gold bull today. With 4/5th of our dollar-gold bull to date directly attributable to currency issues in the past few years, we have already paid our dues in this early currency stage.

The second stage witnesses gold decoupling from the usual exchange rates on pure investment demand. The modest gold rises in the first stage, even though largely offset by currency movements, inevitably attract in the early contrarians who perceive a major secular trend change early. They start buying gold as an investment. Gradually their buying pushes the gold prices up high enough that the Ancient Metal of Kings rallies in all currencies. After a year or two of stage-two rises, general investors follow the contrarians' lead into gold and push it even higher.

Some gold bulls end after stage two, but if the general public gets involved then stage three ignites. There is no rush like a gold rush, and a speculative mania in gold kindles an inferno of popular greed that even exceeds that of the late 1990s tech mania. All of us humans have a natural affinity for the beautiful yellow metal buried deep somewhere in our hearts, and when gold lust is sparked on a large scale vast sums of money start deluging into a very small market. Gold shoots vertical into a bubble before finally collapsing after it has sucked in enough capital.

If you were to graph these three stages of a gold bull, they would look like a parabola rising to the right. The first currency stage is a modestly rising line over a few years, like the euro-gold line above, nothing too impressive. The second investment stage witnesses a dramatic acceleration in gold's upslope and gains that dwarf the early currency years. Finally the third mania stage is when the parabola turns vertical in the final months or year leading into a blistering bubble top and subsequent crash.

If you imagine a parabolic price graph, think NASDAQ 2000, you know that the vast majority of the gains happen in the second and third stages of the parabola. This means that all of our stage-one gains to date, as magnificent as they have been, are probably only a small foretaste of the feast to come!

While the divisions between gold-bull stages are fuzzy and gradual, if I had to pick a single immensely important catalytic event that could do more to usher in stage two than any other I believe it would be euro gold finally breaking decisively above its vexing €350 resistance line. When this breakout happens, tens of millions of Europeans and other foreign investors are going to suddenly believe in this bull. And their capital will follow forcing gold up high enough to decouple it from the chains of the fiat currencies.

As this chart shows, we recently had a shot at €350 in early April but it failed. For a variety of reasons I discussed at the time in "Euro Gold Challenges E350" euro gold was just too technically overextended after its sharp March rally and couldn't break through to new all-time highs. But, this giant ascending wedge being created by the euro's rising support and flat resistance lines virtually assures a breakout is coming sooner or later here.

The higher the euro gold's long-term support line trends, the tighter the technical gap between prevailing euro-gold prices and the €350 breakout becomes. As euro gold's support base creeps higher, the distance it will have to cover to break out is relentlessly shrinking. It would be far easier for euro gold to break above €350 for example if it launched its rally at €325 as compared to €300.

€350 is only 8% above €325, but 17% higher than €300. As long as its long-term support line continues trending higher as in this graph, it is only a matter of time until the euro blasts through this troublesome €350 line that is tending to blind foreign investors to the reality of a true global gold bull. The euro-gold technicals virtually guarantee this breakout.

I even suspect that the coming fall of €350 is even more important for this gold bull than the fall of the $325 Maginot Line was for American investors back in December 2002. Europeans have a much deeper cultural affinity for gold than Americans so if an €350 breakout brings them back into gold en masse their capital inflows could be the very trigger that lifts gold above the currency melee into stage two.

Unlike today's Americans including I who have no memory of or personal experience with rapid currency devaluations and out-of-control inflations, there are many wealthy European investors who do remember these terrifying times. With all the strife in Europe in the past century, memories of the importance of gold as compared to inherently worthless fiat paper run deep. It takes generations for cultures to forget just how quickly an entire middle class can be utterly destroyed if they have no gold when a paper currency fails.

Now I am certainly not arguing that Europeans fear the end of the euro. It will eventually fail in the distant future just like all fiat currencies of course, including the US dollar, but almost certainly no time soon. I am merely pointing out that Europeans have a deep cultural love for gold unknown in the States. While Americans often have to be dragged kicking and screaming into gold initially after a great deal of persuasion, in Europe gold is far more widely accepted as a necessary component of every prudent portfolio.

So once the all-time euro gold highs near €350 are surpassed, financial advisors all across Europe can whip up charts to show their countless clients that this gold bull is for real. Unlike Americans who often need a hard sell to own gold, many Europeans will be thrilled to see gold moving and innately want to invest. Since the global gold market is so amazingly small compared to stocks, bonds, or other currencies, it won't take a lot of extra marginal capital in the grand scheme of things to really get gold moving.

We are continuing to closely monitor this fascinating euro gold situation and I will certainly discuss the €350 breakout in our acclaimed monthly Zeal Intelligence newsletter for our subscribers when it finally happens. I suspect there is a good probability that there will be some excellent opportunities to trade elite unhedged gold stocks as this long-awaited successful €350 challenge goes down. I can't wait!

The bottom line is euro gold remains in a not-so-widely-recognized stealth bull market. Its support continues to climb higher and higher and its key 200dma is also meandering higher. If these trends persist, an €350 breakout to new all-time euro gold highs is inevitable.

The probable resulting surge in gold investment demand out of Europe may indeed prove to be the very spark that ignites stage two of this gold bull when things really start to get interesting. Watch €350 gold!

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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