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February 04, 2008

Dow / Gold Ratio Tells The Story
by Captain Hook

The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, January 15th, 2008.

Don't say you were not warned. Warned about what? The coming depression in the global economy perhaps? No - that's not what I am referring to; however, this should be a very big concern to all never the less. Could it be an impending derivatives debacle emanating in the States due to an unexpected bond market implosion brought about by investor concern? No - that's not it either; but again, this is an item everybody should be concerned about considering implications for housing, credit markets, and the economy at large in turn. And certainly these are all legitimate and significant concerns worthy of warning.

So what could it be then? What's the big risk being warned about now? Answer: You are being warned not to trade out of you precious metals investments because although things appear stretched at the moment, conditions should get much more so after what should prove to be a relatively brief respite whenever it arrives. What's more, and as you will see below, I am not suggesting the present move cannot get more stretched as well. In fact, I think this is exactly what will happen in coming days. And while I could always be wrong, a great deal of technical evidence associated with both weekly and monthly charts encompassing the entire precious metals complex is suggestive things are just getting rolling, and that while messages evident on daily plots (and some weeklies) should not be ignored by shorter-term traders, all other positions should remain in tact for the big payoff coming down the pike.

What this means is increasingly people who have been ignoring warning signs like the ones listed above should soon be 'finding religion' as it pertains to a prognosis for the future that more closely resembles reality. And when they do, gold will become a far more important part of their investing focus, likely to the point of manic proportions in the end. In the meantime however, and in monitoring the progress of the bull market in gold, the attached Elliott Wave Count continues to appears to capture the essence of the move, which calls for far higher prices in the end. How high can prices go in the end? Well, according to Nick Laird at Sharelynx.com, if a realistic inflation rate history were used to adjust the gold price in today's dollars, such as the one provided by shadowstatistics.com (SS), prices should be heading up to $5000 eventually. (See Figure 1)

Figure 1

Returning to the present once again however, and in endeavoring to forecast the strength of the current impulse, it appears the Baltic Freight (Dry) Index (BDI) is beginning to accelerate lower at present, which at first should have a positive reaction on gold prices, and then negative. The initial positive reaction would be rooted in the discounting of an accelerated 'need for speed' in monetary debasement rates, which is exactly what should happen in days to come as monetary authorities react to a perceived threat of deflation. And then once this buying power runs out, and prices start falling, deflationists will take this as a sign the sky is falling; possibly driving gold prices lower than need be. If we use Alf Field's preferred count / projections attached above, gold should top out soon just shy of $1,000, and then drop back to the $830 area if history is a good guide. Of course if we use a traditional 3-box point and figure chart, gold counts up to $1,170 this move based on the strength of the present impulse. Thus, we have a range in play based on these two parameters, with the big message here being 'don't sell' as we are in Primary Wave III higher, where corrections should typically be relatively shallow, and advances potentially more robust than anticipated.

You know to a degree I should just wrap things up here today due to the importance of this last statement for most, that being sit tight with the majority your precious metals investments through any impending corrections in Primary Wave III due to unpredictability, but for those who insist on attempting to catch the swings under such circumstances, we can help you too. As you may know, this cannot be done by simply looking at a gold chart however, where for example the weekly gold plot is now exhibiting negative divergences in key indicators, but as per above prices can run far further than such influences suggest. No - to do this we must employ ratios in measuring key inter-market relationships that give us a better idea of just how much pressure still needs to escape the pipe. And in this respect we have two measures that should be brought to your attention. First is the Gold / US Dollar ($) Ratio, which currently has a Fibonacci resonance based target of approximately 13 (not far away now). And then we have the old standard that appears to still be doing the job handily, the Dow / Gold Ratio, which as suggested in the title of this essay, is telling the story.

What does this mean? It means that although nominal price extremes may vary, meaning the absolute top in gold and bottom in the Dow might not correspond to a low in the Dow / Gold Ratio, in general an intermediate-term degree reversal in these trends should be signaled at major inflection points, which in this case would be a reading of approximately 10 if the long-term monthly plot attached directly above provides us with any predictive value. The reason 10, the round number, should provide support is because on the way up this metric provided stiff (multi-year) resistance, which means on the way down it should provide commensurate support if history is an indication in such circumstances. What's more, this view is supported by the fact this an election year, meaning monetary authorities will put the 'pedal to the metal' as far as the printing presses are concerned, which in turn is supported by the view stocks should find a bottom in March at a crash low, as suggested in our analysis last week.

Applying this to what we know about the Dow's structured top, where now that the diamond has broken to the downside we can talk about a downward slanting head and shoulders pattern measuring to 10,800, we know that a move to this level is quite possible, which of course puts gold far closer to an $1,100 interim top using a Dow / Gold Ratio of 10 as opposed to $1,000, which most people are looking at due to the fact hurdling this measure puts pricing into four-digits. (Apologies for the length of that sentence.) And wouldn't you know it, $1,100 is right in the middle of the range identified earlier, which would make it a 'moderate view' then on this basis. So again, for those of you who must trade this top,$1,100 looks as good as any other guess, but please remember this is only a 'guesstimate' based on the above analysis. If the Dow were to plunge lower, or bottom higher, obviously results will vary. In this regard, I suggest you stay tuned to our ongoing analysis of prospects for the stock market.

Just as an aside, which I will throw in here as it's good a place as any, you may remember me discussing merits of the Horizons BetaPro S&P/TSX 60® Bear Plus Fund if the global growth metric were ever to come into question in consideration to Canadian equities (largely oil based) which are currently trading as if they are immune to global credit related contagion. Based on technicals displayed in the plot below, this belief system should get questioned any day now with a break higher (lower for the TSX 60), where although I am not forecasting much more than a normal 10-percent correction in the index at this point, things could get more interesting by March. This fund makes for a good hedging instrument for non-aggressive investors, and the timing looks right on cue at the moment, as was our call on FXP last week. For risk averse investors who buy here then, an exit at $24.50ish appears appropriate. (See attached.) (See Figure 2)

Figure 2

HXD topped out at $16.50 four days later.

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. However, if the above is an indication of the type of analysis you are looking for, we invite you to visit our newly improved web site and discover more about how our service can help you in not only this regard, but on higher level aid you in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

On top of this, and in relation to identifying value based opportunities in the energy, base metals, and precious metals sectors, all of which should benefit handsomely as increasing numbers of investors recognize their present investments are not keeping pace with actual inflation, we are currently covering 68 stocks (and growing) within our portfolios. This is yet another good reason to drop by and check us out.

And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. We are not registered brokers or advisors. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Do your own due diligence.

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