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August 06, 2006

More Thoughts on the Coming 4-year/8-year Cycle Bottom
by Clif Droke

In the June and July newsletters we examined whether the XAU index had reached a short-term bottom and reached a conclusion that, based on numerous technical/internal and cyclical studies, the gold/silver stocks were indeed "oversold" enough to begin an oversold rally off the June lows. The leading gold and silver stocks did just that, with many meeting resistance at the 60-day and 90-day benchmark moving averages as expected but with a few managing to overcome these moving averages on the upside. That showed greater than anticipated strength and suggested that higher highs were on the near horizon for many gold and silver stocks.

Some of the price patterns that have since etched out following the June internal low in many instances carry bullish implications. But other gold stocks have lagged behind and still haven't confirmed their June lows as being the dominant internal low. It's truly a mixed market. Adding to the confusion is the fact that instead of leading the way higher in recent weeks (as is normally the case following a major low), the silver stock group has lagged slightly behind the golds. This is especially evident in the internal momentum indicators for the silver stocks versus the gold stock group as shown in our HILMO series of indicators (based on the net number of new highs made in both groups on a rate of change basis). Granted, it's not a huge disparity but even a slight lag is enough to give one pause for some concern.

Finally, there's the ever-present matter of the dominant 4-year (and 8-year) cycle bottom which is due to touch down around September 1. This downward pressure from the latest 4-year cycle could add to overhead resistance pressure for many gold and silver stocks in the next 3-4 weeks, so we'll have to anticipate this and remain vigilant in the remaining weeks of August.

Yet despite the overhead pressure from the bottoming 4-year/8-year cycle, there are some good reasons to believe that the price lows made in June by most actively traded gold and silver equities was in fact the dominant intermediate-term "internal" low for the precious metal stocks as a whole. The infamous stock market technician Joseph Granville, in his book "A Strategy of Daily Stock Market Timing for Maximum Profit," distinguished between a market's "internal" versus "external" low and he maintained that the internal low was visible based mainly on investor sentiment (psychology). Specifically, an internal low is a function of price plus capitulation at the bottom of a price decline when the greatest number of traders/investors have thrown in the towel and have given up on stocks, walking away from the market. We saw this happen following the June low in precious metals equities (with the bullish percentage on gold stocks falling from over 90% to under 60%) and since that time higher lows have been made in many individual gold and silver stocks.

Another potential positive in the current market is that the month of August begins season strength for the gold stocks in general. Since 1994, there has been only one year when August was a losing month for the XAU gold/silver index, namely August 1998. This of course was exceptional in that not only was the 4-year/8-year cycle bottoming hard, but a major deflationary trend in commodities and currencies was underway and was felt around the world's major financial systems. Since this time inflationary pressures are much greater in commodities while deflationary pressure are virtually non-existent at this time, a similar experience for gold stocks isn't expected. True, there can still be some downward pressure felt as a result of the bottoming 4-year/8-year cycle in the coming weeks but those lows made in June are likely to hold up in most gold stocks. Even if some are violated they aren't likely to be substantially violated on the downside and the "internal" (psychological) low made in June will still stand.

Let's take a moment to go back and see how the XAU reacted in the face of previous 4-year cycle bottoms. We've already discussed the last 4-year bottom from 1998 (which was also an 8-year cycle bottom) when the XAU was down 15 points from the start of the month until the end. Also worth mentioning is that back then in '98 the XAU was already in a dominant interim downtrend since topping in late April of that year and hadn't managed a meaningful rally until after the cycle bottomed in early September. This time around the XAU has already had at least one meaningful rally off its June lows and is trying to establish this low as the dominant interim price bottom.

The most recent 4-year cycle bottomed in September 2002 of that year (the subsequent lower low in October in many broad market indices in 2002 was not a function of the 4-year cycle but of the master weekly trading cycle which bottomed 4 weeks later). While most major stock market indices made their lows in October '02, the XAU gold/silver index also made its low that year in July and made a series of higher highs and higher lows from there. In other words, the mining stocks were showing relative strength compared to the broad market when the previous 4-year cycle was bottoming. Investors who spotted these positive divergences in this sector did extremely well in the month that followed the 4-year cycle bottom in 2002.

Now that we're only about four weeks away from the current 4-year/8-year cycle bottom it can be seen that the XAU, HUI and GOX gold stock indices have all made higher highs and higher lows since bottoming earlier in June and in recent weeks have displayed relative strength. Since the precious metal stocks tend to benefit from Fed liquidity pumping ahead of important trading cycles before most major sectors, we could see even more improvement later on once the current 4-year cycle bottoms in early September.

Short-term internal momentum for the gold stocks is still rising, which can be seen in the short-term GS HILMO indicators. Internal momentum as measured by the GS HILMO indicators (gold stock hi-lo momentum), which measure the rate of change in the net new highs among the actively traded golds, is still rising and should allow for support during pullbacks in the near term as well as a further recovery potential among the gold stocks that have shown relative strength recently.

The XAU index and AMEX Gold Bugs Index (HUI) recently closed above the 30/60/90-day moving averages. The pivotal resistance levels are directly overhead in XAU, HUI and GOX and a breakout above the 150 level in XAU would be most welcome. However, we'll need to see a confirmation of the next breakout in the gold stock sector's leading indicator, Freeport Gold (FCX). For an upside breakout to be legitimate, near term, it should be accompanied by a breakout in FCX above the $60 level. Currently FCX is slightly below its 90-day moving average and closed most recently at $55.13 on August 4.

Another leading precious metal stock already above the 30/60/90-day MAs includes Inmet Mining (IMN:TSX). We pointed out last month that IMN had a nice looking chart pattern with the 60-day and 90-day moving averages still rising at a fairly good rate of change in reflection of the lingering interim upward bias which allowed it to reach its May highs recently. Historically, when IMN leads the XAU usually follows (albeit sometimes with a lag).

Clif Droke
ClifDroke.com

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving internal momentum and moving average systems, as well as securities lending trends. He is also the author of numerous books, including "How to Read Chart Patterns for Greater Profits." For more information visit www.clifdroke.com.

Copyright © 2003-2008 Clif Droke

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