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October 20, 2004

Gold Breakout Imminent?
by Chip Hanlon

Shouldn't this article's title have been written a few days ago, with gold once again above $420 and within striking distance of a break to new highs? Actually, I think this headline is more compelling now that gold has backed away from those levels and has caused many to suspect that a larger pullback is on the way.

This essay has little to do with fundamentals and more to do with the chart pattern that has developed in the metal over the course of this year. For fundamental commentary, my recent article, "Bonds, Gold and Oil: More of the Same," provides my case for creeping inflation and, thus, gold as a timely investment. The same piece, it should be noted, also highlights that I am not one to breathlessly predict higher gold prices at every turn as the gold bugs always seem to do.

I am, however, writing this article to suggest that higher gold prices may finally be at hand, an argument that is based on how strikingly similar the recent price action in gold is to the consolidation phase we saw in the metal a couple of years ago.

As gold finally started to rally from its lows near $250/ounce in early 2001, it did so in a very orderly fashion until finally encountering resistance near $325/ounce more than a year later. A look back at the correction that ensued is what I thought investors today should see:

In the chart above (May 1- December 1, 2002), it can clearly be seen that the first correction of that run, while sharp, was enough to shake out weak holders and provide enough relief to set the stage for the next phase of the metal's rally. The balance of that correction (early August through late November) was one of time, not price, and actually formed a nice, orderly pattern of higher highs and higher lows.

Now, look at gold's action over the last 12 months:

Is it me, or do those two corrections look virtually identical? Let's see... big rally, scary correction, then some backing-and-filling in a quietly positive march back to old highs. No, I don't think it's just my imagination.

Is this analysis too simplistic? Admittedly, I presented the price action above without additional studies to more clearly show the similarity of the two moves, so yes, the thinking presented is rather simple. To this point, however, I would ask a little leeway; I'm an experienced, widely-quoted technical analyst who has peeked at more than his share of charts, one who has made some pretty darned accurate predictions on currencies, interest rates and equities in the last couple of years (if I do say so myself). To highlight one such call as well as to prove that I'm not a stopped-clock precious metals bull, I encourage investors to also glance at "Silver Rallying on Questionable Rumors" from earlier this year. In today's case, I'm trying to share a little bit of my "gut feel" or instincts with readers, something I feel I can rightly claim.

By all counts, short- and long-term, gold simply appears to be in a powerful bull market, one that seems poised to make another push higher in the near-term.

So what, exactly, am I suggesting for investors?

First, don't forget what the price of the metal did when it did breakout from that first consolidation range by moving above $330/ounce... below is the same chart as the first one shown in this essay, but extended by one month:

Here, the start of the rally that took gold to $390 in just two months can be seen. Gold literally exploded when it broke through resistance.

Likewise, a move solidly above $430 would likely see similar action, in my opinion. Indeed, I think the move would be even more explosive. Why? For the answer to that question, I need to include one more chart, this one longer-term in nature:

A nearly 15-year chart of gold shows heavy, heavy resistance in the area near $400, the level that I warned coming into this year might bring about a period of consolidation. Indeed, if I am wrong in suggesting today that a gold price breakout is imminent, it will be that 3-year resistance level from the early-1990's that causes the metal to continue its sideways action. If I am right, however, a break to new highs will be made more significant due to that past resistance seen above.

This leads me, finally, to my point: despite the volatility in 2004, all that has really occurred is that gold has paused to consolidate its gains. In my opinion, the worst-case scenario for the metal will bring more of the same. In the best case, the $430 level falls and gold sprints higher.

Take a look again at gold's price action over the course of this year. Since that first big pullback to $375, a clear pattern of higher highs and higher lows can be seen; with this in mind, any rally from here will put considerable pressure on that $430 level and might be the surge that finally causes the breakout.

By my analysis, there seems to be little chance of a meaningful pullback in the price of this metal; the fight appears to be between more sideways action or a powerful upside breakout. Could the metal pull back a few dollars, say to $400, before surging again? It could without changing any of the thinking outlined above.

Investors, however, should not get cute about their pricing/timing of precious metals purchases at this point. For those that don't yet own any gold but want to, it would be wise to purchase at least a partial position now for fear of missing the boat and being left on the dock as gold sails above $500, which is what I expect to happen quickly following the next break to new highs.

Again, here's the point of all of this: don't get cute - act!

Chip Hanlon
Euro Pacific Capital, Inc.

Copyright © 2004 Euro Pacific Capital, Inc.

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