Embrace the Gold Stock Panic and Buy!

By: Michael Swanson | Tue, May 23, 2006
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On May third my article Gold Is Getting Overbought was published on all of the leading gold websites. In it I wrote, "over the next few weeks I expect the metal to pull back and provide an entry point in the gold stocks."

Well, Gold and gold stocks did pull back and in such a way that took even me by surprise. But it wasn't a huge shock. Gold markets have always had a tendency to overshoot our expectations and this was no exception. The XAU gold stock index fell right through its support zones and all the way down to 133 while gold dropped more than a hundred points. Gold bugs were smashed as pure panic hit the market.

What we have witnessed is a typical gold correction. We've seen gold stocks correct over twenty percent while rising in an intermediate-term uptrend channel several times over the past few years. But each time it happens it takes people completely by surprise.

You see, there are gold bugs who never think the gold market can pull back. Despite seeing this type of thing happen over and over again throughout the years, they always are convinced by rising gold prices that this time might be different. Then there are others who get attracted to the gold market because of its big rallies, not having a clue what they are getting into. And boy did a lot of people like that get into gold thanks to all of the attention it has recently received in the financial media. Now those people have probably been convinced by this big drop that gold isn't, in fact, in a bull market.

When gold rallies what happens is that some people just get stupid at the top. They get greedy and buy on margin and overextend themselves. Then when a correction begins they hold on hoping for a bounce. Each day as the market drops they lose money on their position and they feel the pain a little more. Finally they can't take it anymore, mentally or financially, and give up by hitting the sell bottom (Capitulation). That's how these gold corrections come to an end and that is exactly what happened on Friday. A lot of nervous Joes and overextended speculators get flushed out. They might even vow never to buy another gold stock. But don't worry, somehow they'll buy in near the next top. We need to take advantage of their mistakes.

The XAU fell Monday right down to its long-term technical support level and bounced. As you can see from the chart above, the XAU rallied off of its support trendline that goes back to the May 2005 bottom. It also bounced off of its 150-day moving average.

Early last week I told my subscribers that I would be on the lookout for a bottom because the XAU/GLD ratio had become extremely oversold. Each time this had happened in the past several years a major bottom in gold stocks came within a week.

Monday morning in overseas trading gold fell below its 650 support level down to 635 where it reversed. It clawed its way back into the open and going into the close gold stocks showed strength against the metal. I take this as a very important buy signal and confirmation that gold stocks have indeed put in a major bottom. If they fall again the downside is so limited at this point that I have to buy some here.

In my recent writings I have held the theory that gold stocks actually entered stage two of their bull market back in December. What is interesting about this recent correction is that Friday's bottom came right on the XAU's 150-day moving average. If Friday's low indeed marks the new bottom for gold stocks this will be the first time that the XAU bottomed right on or above its 150-day moving averages. All other previous bottoms happened with the XAU well below its 150-day moving average.

This is a sign of how bullish the gold market is becoming.

The XAU gold stock index appears to be starting the process of creating a new cycle bottom. The XAU now has resistance at 149, which would be a 1/3 retracement of the correction, and then at 153. I expect it to rally to one of these two levels and then dip back down near support, probably to the 140-143 level. It should then bounce, beginning another leg up to its 52-week high.

My goal is to have a large position in gold stocks by the start of their next leg up. I'm going to buy enough gold shares to have 1/2 of this position today. I then plan on doubling my position once gold stocks consolidate and turn up.

Why half now? It is possible that after a bounce gold may fall through 650 into the 615-630 area. That would cause the XAU to either hold support at 133 or briefly dip below 130. I don't think this will happen, but I want to give myself room in case it does. Buying at this level will help me keep my average gold stock entry point low and leave some buying power for later.

Right now though almost everyone has been rattled by last week's death spiral in gold stocks. But you know as well as I that the best time to buy stocks is when everyone else is too scared to do so. The best time to buy gold stocks is when they fallen over twenty percent during a bullish uptrend.

The best time to buy gold stocks is right now. Don't be fazed by the drop in the gold market. Keep your wits. Embrace the panic and get in at these ridiculously low levels.

To find out what gold stocks I am buying subscribe to my free weekly gold market update. Click here: http://www.wallstreetwindow.com/weeklygold.htm.



Michael Swanson

Author: Michael Swanson

Michael Swanson,

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