Gold Stock Bull Healthy

By: Adam Hamilton | Fri, Feb 4, 2005
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With the HUI unhedged gold stock index grinding relentlessly lower since mid-November now, it is understandable that gold stock investors are getting nervous. It is always the most recent price behavior that drives sentiment, and the HUI's recent price behavior has certainly been weak.

It is natural for investors and speculators to grow concerned if a short-term trend is not moving in our favor. At its very core, speculation is an internal emotional struggle, not an external battle against the markets. When the markets move against our trades or even our biases, fear begins to well up deep in our hearts. The longer the short-term trend conspires against us, the greater the emotional pressures grow.

This emotional stress can create problems though. We humans are created as inherently emotional beings, but in order to be successful in the markets we must trade without emotion. Successful speculators trade on cold, hard logic and probability theory. Since emotions kill objectivity, they are ruthlessly suppressed by elite traders.

Unfortunately the only way to cultivate a totally neutral unemotional view of the markets is through long merciless real-world experience. The more investments and speculations you make, win or lose, the greater your understanding of the markets will grow. Gradually the natural human knee-jerk emotional responses are eradicated and a calm experienced rationality takes over.

While commentary like this will never be a substitute for priceless experience won through your own real-world trading, I would still like to present an emotionally neutral perspective on gold stocks. There is a lot of angst and confusion out there regarding the HUI's latest negative machinations so perhaps a strategic view can prove useful to some of those struggling to understand what is going on.

In the markets, just like life, the tyranny of the immediate tends to crowd out the far more important big picture. Whenever you find yourself anxiously pondering a recent development with an inordinate amount of concern, the best way to return to emotional neutrality is to zoom back out and consider the latest move within its proper long-term context.

The gold stock bull, regardless of its latest weakness, remains quite healthy technically. All bulls flow and ebb, taking two steps forward in spectacular uplegs before retreating one step back in necessary corrections. The HUI is simply sojourning through one of these periodic correction phases which is no big deal and probably nothing to be concerned about.

When you consider the entire gold stock bull to date, as this chart below reveals, the HUI's latest correction is well within character and not at all out of the ordinary. The index is just ebbing as all bulls do from time to time, but the core underlying technicals remain rock solid and very bullish.

The strategic gold-stock-bull picture is crystal clear in this long-term zeroed-axis chart. The HUI bottomed on November 14th, 2000 just under 36. At its bull-to-date highs near 257 a little over a year ago, this premier unhedged gold-stock index was up a breathtaking 614%! Even today, with the HUI languishing near 200 at the moment, gold stocks are still 450%+ above their secular bear lows of late 2000.

With the NASDAQ still down about 60% from its lofty bubble heights of 5 years ago the 450%+ gains in gold stocks over roughly the same period of time really underscore the strong secular bull in gold stocks. The recent HUI weakness, down 18% correction to date when we made this chart Wednesday evening, really pales in comparison to the gains already won in this bull.

A true unemotional neutral perspective on the HUI, warts and all, is easiest to obtain when its long-term technicals are considered in context. From its periodic uplegs and corrections, to its long-term support lines, to its similar consolidations, the HUI technicals really do paint a healthy picture of a nearly textbook perfect secular bull market in gold stocks.

Bull to date, the HUI has had five major uplegs and five major corrections. Our chart above is divided into these ten sections. The five uplegs and first four corrections are set in stone, but today's correction is still a work in progress so its numbers are not final yet. Underneath each upleg and correction on the chart its gain or loss as well as the number of trading days it ran are noted.

As the HUI flows and ebbs like all bulls, it gradually carves a series of higher highs and higher lows. Strong uplegs erupt from interim lows and catapult the index higher, often to fresh new bull-to-date highs. After two steps forward in the uplegs, sentiment is just too euphoric so a correction is necessary to drag it back down into balance. This one step back temporarily bleeds the index down, but usually to a higher interim low.

Over time this rhythmic pattern of upleg correction upleg correction carves a bull-market uptrend like the HUI's in this chart. The series of higher interim lows after each correction, when connected by straight lines, form rock-solid long-term support zones. Over an entire bull the slopes of these lines gradually become steeper and form a linear parabola, ultimately shooting vertical when the final mania blowoff top is reached at the very end of a secular bull.

In our chart above, the HUI has only had one distinct support slope change so far in its bull. In 2002 it started to bottom above its original long-term support line, marked with the blue 1, and ultimately formed a newer steeper support line noted by the blue 2. This latest primary support line has not once been decisively broken in the last several years since it formed.

Today the HUI, for all its sound and fury, remains above this current long-term support line. The HUI appears to be in no danger at all technically and is highly likely to bounce off this support line in the coming months. If you carefully examine this support line in the past few years, you will note that every time the HUI approached it it was a very bullish time to buy, not the time to get anxious and worried about an already mature correction.

As long as the index does not decisively break this long-term technical support, then the gold stock bull will remain healthy technically. Any short-term weakness, regardless of the psychological pain and sentiment angst it causes, is ultimately totally irrelevant and not even worth thinking about as long as the HUI remains above its long-term support.

Another reason folks are concerned is the HUI's last major upleg in 2004. Bouncing off its May lows at its long-term support line, the HUI was only able to claw 45% higher in the next 134 trading days. In most markets a 45% gain in a half year or so would be stupendous, but in light of the stellar expectations speculators place on gold stocks it is well below average in this realm.

Bull to date the average major HUI upleg ran 98% higher over 137 trading days, over twice as big as the 2004 HUI rally. In addition, the 2004 HUI rally did not take the index up to new bull-to-date highs, further spooking the bulls. The flagship gold-stock index nearly hit 257 in December 2003 but only 245 in November 2004.

This puzzling development is leading some to believe that the gold-stock bull may be over since bulls are supposed to carve higher interim highs, not a lower interim high. I suspect this is merely an issue of perspective as well though, and a careful examination of the chart offers some insight that ought to disarm anxiety.

The biggest uplegs in gold stocks in this entire bull market were upleg 2 in 2002 and upleg 4 in 2003, weighing in at colossal absolute gains of 145% and 125% each achieved in well under a year. In each case, the HUI soared so high so fast that it was stretched far beyond its key 200-day moving average support line. After such breathtaking leaps higher, it seems like the index just needs to consolidate and stabilize to acclimate to its new heights.

After upleg 2 in 2002, upleg 3 was rather anemic weighing in at just 8/20th of upleg 2's raw gains. Upleg 3 reached its interim top just a hair above upleg 2's earlier interim high too, so during this earlier consolidation the gold stock bull really didn't carve any decisive new interim highs either. I remember this time well, as bearishness was very high even though the second greatest HUI upleg was knocking on the very doorstep waiting to soar.

Following the relatively small upleg 3 during the HUI's consolidation and acclimation to new heights, the massive upleg 4 sprang to life. It also stretched far beyond the HUI's 200dma and easily achieved major new bull-to-date highs. Upleg 5, however, much like upleg 3, only managed to see gains of just 7/20th of the previous major upleg's. Do you see the pattern here?

Not all uplegs in bull markets are created equal. During some of them, usually following large consolidations where the HUI builds a new base, gold stock investors and speculators bid up gold stocks with such zeal that they soar almost vertical and stretch far above their 200dmas. But after these super uplegs, gold stocks have rallied so far so fast that they really need to consolidate for awhile before launching higher. This gives the markets time to adjust to their new higher price bases.

The below average HUI rally of late 2004 happened to transpire during one of these consolidations following a super upleg. As a matter of fact, if you carefully look at the chart the late 2002 and 2004 consolidations look remarkably similar technically. The latest consolidation is on a larger scale since it is later in the HUI bull and higher in index price, but for all intents and purposes it is painting a very similar technical picture to the earlier consolidation.

These consolidations help explain a lot of technical anomalies that cause anxiety among gold stock investors. For example, the HUI's 200dma, a key technical indicator usually running parallel with a long-term trend, has moderated and turned down recently. This is leading some to declare that the HUI's bull is over. But way back in early 2003 in the last consolidation the HUI's 200dma temporarily turned down as well, and obviously that episode didn't hinder this bull market since super upleg 4 erupted soon after.

In addition, the HUI is now trading below its 200dma, also a big psychological problem for some traders. But such events have also happened before during the last major HUI consolidation. If you have the crucial benefit of strategic perspective, almost all of the short-term developments that look scary in isolation just appear as normal events in the context of a secular bull market's inevitable flowing and ebbing.

The greatest uplegs in this entire bull to date launched from conditions just like ours today. The births of the super uplegs 2 and 4 had several key technical things in common with what we are witnessing now. First, they erupted after long, grinding sideways consolidation periods where the HUI was establishing a new higher base and getting comfortable.

Second, they both launched when the index was trading right on its long-term support line, just as it is today. Finally, the HUI was actually under its 200dma, looking very weak from a short-term technical perspective, when these greatest uplegs in this bull launched. If the coming upleg, number 6, follows precedent, it ought to be stupendous with gains well above average since it can grow from seeds sown in good soil during the 2004 consolidation.

In light of all these technical observations that appear par for the course, I can only conclude that the gold stock bull looks very healthy, alive and well. It is correcting as it ought to periodically to bring overzealous sentiment back into balance, but we have seen all this before and it is nothing new under the sun. If you strive to focus on the big picture and not dwell on short-term weakness, all of this is readily apparent. The long-term charts are emotionally neutral.

Speaking of the big picture, we have a giant gold and gold stocks chart that offers an even more impressive perspective on today's developments. We have been trying to update this once a month and just finished with the January numbers earlier this week. The original chart is huge and freely available at www.zealllc.com/2002/gold.htm in its full-sized glory. It isn't as clear condensed into essay size, but its strategic perspective is just as crucial.

Our giant chart runs from 1996 to the present. Originally developed a few years ago, I have used it to illustrate the difference between secular bull and secular bear markets. A little off center to the right, a bold black arrow divides up the secular gold bear ending in early 2001 from the secular gold bull launching in early 2001. As you can easily see by the yellow gold and blue HUI lines, the entire technical character of bull and bear markets is vastly different.

In bull markets, higher highs and higher lows are the rule. Both gold and the HUI have generally been powering higher in uplegs since early 2001 with periodic and healthy corrections. Uplegs dominate bull markets the majority of the time, with periodic corrections a fraction of the time.

But in bear markets, lower highs and lower lows are the order of the day. Before 2001 downlegs were the norm, falling to lower interim lows, before periodic bear-market rallies erupted to equalize overly bearish sentiment. Downlegs dominate bear markets most of the time, punctuated by occasional bear-market rallies.

As this giant chart shows through contrast, there is simply no mistaking a bull market for a bear market or vice versa. The technical fingerprints of both types of secular markets are so vastly different that they cannot be confused. Bull and bear markets are as different as night and day. The HUI's latest correction is trivial, not even consequential in the grand strategic scheme of things, and looks nothing at all like a true bear market.

It is also important to remember that it is ultimately gold that drives gold stocks, not the other way around. The only reason to own a gold stock is because you expect its profits to rise due to a rising gold price. When gold is soaring, the HUI soars right along with it. But when gold is correcting, the HUI feels the pain as it dives into correction mode in sympathy with gold.

As I discussed last week, gold is still trading as a currency so it unfortunately remains at the mercy of the unfolding countertrend moves in the dollar and euro. Odds are this HUI correction/consolidation will not fully run its course until gold's own correction/consolidation reaches maturity, and gold's near-term behavior is really dependent on the US dollar bear-market rally and the euro correction. The key to HUI timing lies in gold, so watch gold for clues on the next ideal time to throw long gold stocks in a big way.

At Zeal we are eagerly awaiting this next huge HUI buying opportunity, the calm before the eruption of the next major upleg, perhaps super upleg, 6. In the brand new February issue of our acclaimed monthly Zeal Intelligence newsletter just published, I technically analyzed all of the elite blue-chip golds relative to the HUI to find the most promising blue-chip plays for the coming upleg. We'll formally recommend new trades in these outstanding stocks when appropriate.

This analytical exercise also provided performance baselines to dive into extensive junior gold analysis in coming issues of ZI. Junior golds are far more risky, but they offer staggering potential rewards. We have been building a massive database of junior fundamentals for months now and are digging into them technically this month. I will share the results of these studies, and our new stock picks, in the coming issues of ZI.

If you don't yet receive our newsletter, there is no better time to subscribe than before the next major gold stock upleg erupts. All of this essay research forms the foundational base of our actual real-world trades launched in Zeal Intelligence. First-time electronic-edition subscribers will also receive a complimentary copy of the hot new February issue, with your formal subscription starting in March. Please join us today!

The bottom line is the ongoing gold stock bull continues to look quite healthy technically. We have experienced a correction in the last couple months or so, but such events are totally normal and expected in bull markets. As bulls flow and ebb, they advance two steps higher before retreating one step back.

Even more exciting, the HUI's consolidation behavior of 2004 appears to be building a base for the next major HUI upleg. If history proves to be a valid guide, this may even turn into a super upleg, more than doubling in well under a year as the HUI soars to dazzling new bull-to-date highs.

Alas though, investors and speculators can only perceive these awesome opportunities when they ignore their emotions driven by short-term market developments and resolutely focus on the grand strategic picture. Speculators must overcome the tyranny of the immediate that dominates our minds and emotions.


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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