Gold Market Update
Originally published September 19th, 2010.
In recent days many commentators proclaimed that gold and silver have "broken out", but THIS IS NOT TRUE, so what is the current situation?
In the last update we looked at both the bullish and bearish case for gold and silver, what you might otherwise call the best and worst case scenarios. Some interpreted this as fence sitting, but it was no such thing - it was dispassionate pragmatic analysis the result of which is that we won't get caught by surprise whatever happens. However, whilst we have defined what will constitute a breakdown and know in advance what action to take should breakdown occur, we are now in the bullish camp and have been buying a range of selected stocks in expectation of an upside breakout which should lead to a powerful broad based advance.
We require 3 conditions to be be met to be sure that we have an upside sector breakout, which are expected to be synchronously fulfilled. First gold has to break out upside from its current potentially bearish Rising Wedge - new highs are NOT GOOD ENOUGH and to claim they are is amateurish. Second, while silver has undeniably broken out upside from a Triangle, IT HAS NOT BROKEN OUT YET TO CLEAR NEW HIGHS. Thirdly, as more ordinary investors are well aware, Precious Metals stocks indices HAVE NOT YET BROKEN OUT to new highs, although there is strong evidence is that they will do before long.
Let's be clear - we are not trying to "rain on anyone's parade" by making the above observations, we are simply "keeping one foot on the ground". Our outlook for the sector is now strongly bullish for the reasons which we will now set out. Fundamentally the outlook for gold and silver is rosy. There is an unstoppable global trend of competitive currency devaluation underway which is driven by balance of trade considerations and given that governments have this powerful core motivation to devalue their currencies, what better way to do it than simply to print more of the stuff, which means that you can avoid liquidity problems within your economy and placate grumbling workers unsettled by rising inflation by giving them pay rises, using massaged statistics to make sure that their pay rises don't keep up with inflation. The US is the "maestro" of both money creation, which is now absolutely necessary to service runaway debt and government spending, and fiddling statistics, like the CPI and the unemployment figures, the former to cheat people on fixed incomes out of fair cost of living increases and the latter to make things look better than they really are. Another major development of recent weeks in the PM sector is the dawn of a new era of takeover fever, as exemplified by Kinross's takeover of Red Back for a handsome sum and Goldcorp's purchase of Andean Resources for a cool $3 billion.
We don't wish to sound uncharitable but the plain, unvarnished truth is that most investors are idiots. Deep down you know that - most of you reading this have been big enough idiots in your time, as has the writer - if we are honest with ourselves we must own up to it. If aliens from another planet landed on earth and took a look at the long-term charts for junior mining stocks they would fairly conclude that earthlings are drunken lunatics, as a result of seeing the wild, insane gyrations of junior stock prices. They probably have alcohol on other planets, and if they are lucky, something resembling Jack Daniels, although of course it might be green in color. Want down to earth proof of how stupid investors can be? - you don't have to look far to find it. Three years ago silver in the ground was valued at $5, now it is valued at about 50 cents? - get the picture? - is the penny starting to drop? Now you understand why the majors are starting to go after the quality juniors - and what do you think is going to happen if gold accelerates to the upside and silver and PM stock indices break out to new highs and go on a tear? That's right - there will be a scramble by the majors to gobble up the quality juniors and also mid-cap companies with reserves already defined to add their grossly undervalued assets to their depleted inventories. This is why the charts of many junior mining stocks, which have been trampled into the dust in recent months, are now looking so bullish - they have MASSIVE upside potential, and are unlikely to drop even if gold and silver now correct back.
On its 3-year chart we can see that although gold has been rising to successive new highs in recent months, it has been losing upside momentum, as shown by the declining line of peaks in the MACD indicator. A potentially bearish Rising Wedge has been devoloping, breakdown from which would be expected to lead to a drop perhaps back as far as the major support level shown. Whilst acknowledging this reality, however, we are expecting the opposite to occur - gold is expected to negate the bearish implications of the Rising Wedge by the simple expedient of accelerating and busting out of the top of it. If it succeeds in doing this it should run quickly to the parallel return line shown, quickly meaning over the space of several months, which gives us an upside target for the move at about $1500. In addition, there is the possibility, particularly if the prospect of hyperinflation looms, that gold will continue to accelerate beyond the first parallel line towards or to the second, which would see it approach $2000, which given what is going on in the world is not an unreasonable valuation.
A few months back, with the deflation threat very real, it had looked like silver and the main PM sector stock indices were forming a Double Top with their highs of early 2008. Now, however, we can see on the 4-year chart for the HUI index that the pattern forming has morphed into a bullish Ascending Triangle, and that we are now VERY CLOSE TO A BIG MOVE. The Ascending Triangle is a bullish pattern that portends an imminent upside breakout - buyers are having to steadily raise their bids to get stock, hence the rising lower line of the Triangle, and the big overhanging supply resulting from trapped buyers in the large Head-and-Shoulders top reversal of late 2007 and early 2008 has now been almost totally exhausted. This zone of supply, the major resistance shown which is only the top part of the broad band of supply, is of immense technical importance made clear by the fact that the market has been hammering against the top of it for nearly a year now. Thousands of traders are waiting to see which way this breaks. Thus it is obvious that a clear break to the upside will bring traders and investors down off the fence in droves, and drive a huge rally. Likewise a breakdown would be expected to trigger a plunge, although this is considered much less likely on account of the Triangle being of the bullish Ascending type.
If the PM sector breaks out upside soon as expected how does this square with what is going on in the broad stockmarket? After all, it is hardly likely that the PM sector will rise strongly while the broad market is tanking, is it not? This is very true, and the conclusion that the PM sector is about to break out upside must surely mean that, at the least, the broad stockmarket will hold up. So let's now see what is going on the broad market be looking at a chart for the S&P500 index.
As many of you will recall we have been bearish on the broad market for months, with very good reason as it had looked like a Head-and-Shoulders top was forming, but it now looks like if we don't change our tune on this, and soon, we are going to be forced to "eat crow". On the 4-year chart for the S&P500 index we can clearly see the Head-and-Shoulders top, and while there is still the possibility that it will fulfill its earlier promise and lead to a breakdown and plunge, there are subtle but definite technical signs that the pattern is about to abort, which would lead initially to a run at this year's highs in the 1220. This fits with the fundamentals in the US, as while things may be increasingly grim for the guy on the street, the government has the printing press and can carry on doing what it finds easiest and has grown accustomed to in the recent past, which is solve any and all problems by the simple expedient of printing ever more money, what is graciously called Quantitative Easing, abbreviated to QE.
Even though it now looks like the US stockmarkets are going to abort their H&S top and break out upside soon, short-term charts show that with the market having arriving at a key resistance level, we could see a reaction back first, although any such reaction is expected to be minor. As we can see on our 6-month chart for the S&P500 index, although a bullish looking Head-and Shoulders bottom has formed since May (within the larger H&S top already described), the market has risen quite swiftly to the very clear line of resistance at the 1130 level and is now short-term overbought, with a couple of doji candlesticks in recent days indicating indecision and traders bailing out just because the market has arrived at this resistance, which is of course fair enough. So we shouldn't be surprised to see either consolidation or some reaction here in coming days, before the market turns up again and busts out upside.
Quite clearly, if US stock indices do soon abort their Head-and-Shoulders top, which on the S&P500 index would be signaled by a breakout above the Left Shoulder high at 1150, it will be a big green light for the PM sector to stage a major breakout to embark on a sustained and substantial uptrend. This is hardly surprising as the underlying drivers for such an advance will be more competitive devaluation and more QE, not just in the US but worldwide, which will lead to robust inflation down the road and ballooning commodity prices. If the low interest rate environment persists for much longer, the Precious Metals will have the ideal growth environment of rampant inflation and low rates, and even if rates do start to accelerate to the upside, which must happen sometime, this will crash the bloated and fragile US Treasury market, and hot money will then only have one place left to flee, and that is the commodity markets, especially the Precious Metals.