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January 17, 2006

How High for the HUI?
by Roland Watson

Gold and silver stocks are rising again after a long corrective period of a year and a half. Indeed, the initial rise in stock values has been remarkably bullish and there seems to be an open sky above them. But since all bull markets come to an end, then at some point in the future it will be time to fully cash in those gold and silver mining equities and (at least for a while) reinvest the profits in other more attractive markets. The aim of this article is to indulge in some speculation and attempt a guess at where this may end based on Elliott Wave theory and have a look at the HUI bull market to date. The chart is shown below and expresses a simplicity that betrays potential information on where this bull market may ultimately be heading.

The Elliott Wave count has been presented in other articles and the double bottom of the recent long correction at about 163-165 is evident for all to see. The larger numbered waves of 1 and 2 shows us that a marvellous prospect lies ahead for gold equities and those who are prescient enough to own them.

So, wave 3 is now with us and being a statistically longer wave than wave 1, it has wasted no time in displaying its superior bullish credentials.

Those who see no value in the impulse wave theory of Elliott Wave ought to compare it to the three stages of a bull market that is often touted in various gold discussions. The first move up is classed as the "smart money" and those who are in the know quietly accumulating their positions. This is a quiet event on Wall Street and known only to a very small band of investors. This equates to the Wave 1 we saw run from 2000 to 2003.

The second bull move is where the institutional investors realise there is more to this market than a passing spike and they begin to move in too. This is the wave 3 which we are currently starting.

The final phase is when the guy on the street gets wind that there's "gold in them thar mutual funds" and begins to diversify or even totally commit their savings to gold and silver equities in a blow off reminiscent of other sector manias such as the Nasdaq in the 1990s. This equates to the as yet unborn Elliott wave 5 a few years down the line.

So, we see a harmony between Elliott Wave Theory and the fundamentals of investor evolution and psychology.

So, we will now make an assumption based on the fractal nature of Elliott Wave and make some calculations. Fractal means that a price pattern is made up of smaller patterns of the same structure. In that light, take a look again at the now finished Wave 1 from 2000-2003. It decomposes into three bullish waves - 1, 3 and 5 - each bigger than the previous one. This is how we see this whole gold stock bull panning out - one big move upwards outdone by another bigger move upwards. We think that this past three-year move up will reflect the entire three-phase bull market that will extend for at least a decade.

What can we learn from mapping this three-year move to the whole bull? First we break down the price move from November 2000 to the end of 2003.

From the left, each wave is named then given its price move, the time in months it lasted and the predicted Fibonacci ratios for each move based on the last move. So, for example, wave 1 went from 35 to 79, a move of 44. Wave 2 corrected 20 points which the common 50% retracement predicted as 22. As you can see, the Fibonacci numbers worked better for retracement levels than predicting bull moves, but when we scale up the prices, we will use the actual ratios.

Note that waves 1 and 3 lasted the same duration of 6 months. Since the higher degree wave 1 lasted three years from 2000 to 2003, will our new wave 3 also last a similar time span of 3 years albeit at a higher angle of ascent?

Using the price and time ratios of the five-wave move from 2000 to 2003, we scale up and get this table:

Once again, the price moves are given, then the duration in years and we also add the final price the wave ends at. Since wave 1 from 2000-2003 and wave 2 from 2004-2005 have already completed (see first chart), projected times and prices are given in red.

So, based on just scaling up smaller wave patterns, the HUI is destined to top at about 1174 in the year 2016. How do the completed waves 1 and 2 compare to their smaller wave 1 and 2 that ran over 2000 and 2001? Our big 18-month wave 2 retraced 42% of wave 1 while the smaller one retraced 45% but the big wave lasted half the time of wave 1 (1.5 years v 3 years) while the smaller waves were of the same 6 months duration.

In that light, the 4.5-year correction for our future wave 4 seems unlikely and using the same half ratio, we re-assign it to 1.5 years. Also, since great metal bull markets always end in spikes, we feel that 4.5 years for the final wave 5 is too long and suspect it will be lucky to finish in the same 3 years as wave 3.

In summary, we see the HUI moving from 35 to about 1175 by 2012 or a 12-year bull market.

That is a growth factor of 33 in 12 years, does this sound incredible? Well, looking at the last equity mania in the Nasdaq, it took that Hi-tech index to multiply 35 times in a space of 14 years. It was trading at 137 in February 1986 and peaked at 4816 in March 2000. So, we have precedence on our side for such mind-boggling, money-multiply numbers!

Perhaps it would be better to map the behaviour of the Nasdaq bull onto the HUI bull? Well, perhaps it is better to leave that as an exercise for another day. The interesting question will be how vicious the wave 4 correction will be which is projected to occur some time in 2008. Will it retrace nearly 62% of the preceding wave 3 as it minor wave counterpart did to gold bugs' chagrin in July 2002? We don't know, but that period of time would be a probable time to lock in some profits before Joe Six-pack starts banging on the gold equity door!

Moreover, what does this say about the ultimate gold price? Just to complete this exercise, we note to date that the HUI has leveraged gold by about 4 to 1. So, if the HUI grows by a factor of 33, gold ought to grow by a factor of 8, which gives us a final gold price of about $2100. Well, we shall just have to wait and see.

In the meantime, wave 3 is progress. So, unless you hate seeing your investments grow, you need to be on it!

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99. To view a sample copy of the New Era Investor newsletter, please go to www.newerainvestor.com and click on the "View Sample Issue Here" link to the right.

Comments are invited by emailing the author at newerainvestor@yahoo.co.uk

Roland Watson
http://silveranalyst.blogspot.com

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