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November 09, 2004

Gold Price Action: What Comes Next
by Chip Hanlon

The title of this article supposes that last week's move in the metal through $430 did indeed constitute a technical breakout that will allow for a big move to the upside. Even having an article titled "Gold Breakout Imminent?" recently, I'd actually still like to see a little more carry-through into the high $430's as evidence that this isn't just a head-fake, but for now we'll suppose that gold is starting what will end up as a run toward $500/ounce.

Should that rally occur, what should gold investors then expect?

For a possible answer, below is a 2-year chart of gold over the course of 2002-2003; I highlight it for a look at the action that surrounded gold's first important breakout in its current bull market at $325-$330. As can clearly be seen in the graph below, the breakout in December of 2002 led to a furious rally to approximately $390/ounce:

What I suspect many investors have by now forgotten is the sharp pullback that followed; as can also be seen, the metal retraced that entire advance, retreating back into the mid-$320's.

This is classic technical action - classic. Those who have read more than a few of my commentaries know that I'm a technical analyst first (even my fundamental conclusions are driven by what I see in the charts) and I can't tell you how many times I have seen such action. Did that pullback change the long-term bullish trend for gold? Not in the least - it merely served to shakeout short-term speculators and weak holders of the metal... the area that had loomed for so long as resistance then acted as support.

So, you may be asking: is Hanlon suggesting we're going to see a quick spurt toward the $500 level, then a pullback all the way back here to $430 or so? My answer is that the advice in my last essay still stands, that investors who don't yet own gold, but want to, shouldn't get cute in trying to save a few dollars by picking some clever pullback. Those investors need to take action and simply get in.

However, so long-term holders might have a better chance of holding through the volatility that could very well be seen during this precious metals bull market, here are some thoughts as to why we may indeed see a sharp breakout and pullback in gold much like we did a couple of years ago.

What most makes me continue to think a big run in gold is nigh is the breakdown we saw last week in the dollar (see chart below):

The break to a new short-term low below 85 on the U.S. Dollar Index is clear to see, but I think investors need to keep one more chart in mind:

A long-term chart of the dollar shows something very important: there is huge, I mean HUGE, dollar support near 80 on that same index, an area where a massive triple-bottom was built over the course of 5 years on the early 1990's.

If I'm right, the dollar's breakdown will lead it to push down toward the 80 level, but I do not believe for a second that this support zone will go down without a fight. A near-term dollar breakdown concurrent with a big spurt higher in gold is likely. But a technical pullback in gold like the one we saw two years ago, a surprisingly large retrenchment back to the $430 level, could also easily occur as the dollar mounts a counter-rally off that 80 level.

Now, I know it's hard to imagine what could allow the dollar to mount a meaningful rally from here; heck, we're even seeing some of the mainstream Wall Street firms warn that the dollar might be due for a fall... they're 3 years and a 30% decline late to the party, of course, but thanks for the warning, guys.

Indeed, this is precisely what makes me suspect we will see a powerful, unforeseen counter-rally in our currency as it reaches that 80 level -there are a few too many people joining the weak dollar party. If I don't like such sentiment when I see it in the stock market, then even as a long-term dollar bear I have to approach the developing situation honestly, remind myself that no market moves in a straight line and acknowledge that a few too many folks are promising a dollar meltdown at present.

Again, let me state clearly: it should not be at all comforting to gold bulls (dollar bears) that mainstream Wall Street analysts are noticing the trend; aside from the thought-provoking Stephen Roach, I am not aware of a single mainstream "strategist" that has an ounce of credibility on the subject. This sudden awareness suggests that it's getting late in the dollar's current down-leg and that Wall Street's analysts should, as usual, be utilized by investors as the reliable contrary indicators they tend to be. They probably need to be shaken out by a counter-rally before the next big dollar down-leg materializes; how this may play out is simply a little too far out to predict... we'll have to analyze that situation as it approaches.

For now, though, back to the implications for gold: we're certainly dealing with less chart resistance in the metal from here on up than it has had to face in the last couple of years, so maybe my thesis will prove incorrect and it'll just keep running. This thought, in fact, is precisely why my point from last week still holds. I repeat: don't get cute, get at least some exposure to gold NOW.

Keep in mind, however, that this article is being written largely in an effort to help those that want to hold gold as a long-term investment stick with it in coming months by preparing them for the volatility we will almost certainly face.

Chip Hanlon
Euro Pacific Capital, Inc.

Copyright © 2004 Euro Pacific Capital, Inc.

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