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Gold's Young Upleg

By: Adam Hamilton | Friday, February 15, 2013

Gold has suffered a tough slog lately, unable to advance despite central banks aggressively inflating their money supplies all over the world. Seeing gold stuck in the mire despite very bullish fundamentals has certainly exacted a psychological toll on traders. They are irritated and discouraged after watching the yellow metal inexplicably languish for months. But technically gold still remains in a young upleg.

The mortal enemy of successful speculation and investment is emotion. Greed seduces traders into buying high, while fear frightens them into selling low. This of course is the exact opposite of the buying low and selling high necessary to multiply your wealth in the markets. After decades of trading, I believe the greatest antidote to succumbing to popular greed and fear is perspective. Context is everything.

As humans, we all have the natural tendency to extrapolate the present out into the indefinite future. When life is going great we feel nothing will ever go wrong again, and when life is vexing we feel things will never go right again. I call this the "tyranny of the present". It spills into our perceptions of the markets in an all-encompassing way. Traders naturally assume today's conditions will persist forever.

When a price drifts listlessly like gold's has recently, traders' bearishness grows with each passing day. Eventually they throw up their hands in disgust and capitulate, figuring the bullish case must have been wrong. The recent poor price action dominates their minds, that's all they can think about. But zooming out to get more perspective frames gold's slog quite differently, as a consolidation within a young upleg.

Gold's current slump began in late November and accelerated in December. Ever since late that month, it has been inexorably grinding sideways and trying traders' patience. Gold has indeed been fairly weak in that isolated timeframe. But the big picture of what led into this recent consolidation reveals it is actually quite bullish. Considering gold's technicals in longer-term context quickly dispels the current fears.

Gold Technicals 2011-2013

The context necessary for understanding gold's recent lethargy begins a couple years ago in early 2011. The metal rallied nicely that year propelled by its usual strong spring seasonals. It then stalled out as summer arrived, heading into its usual summer doldrums. For gold's entire secular bull, predictable global demand spikes driven by income-cycle and cultural factors have driven pronounced seasonality.

This metal tends to rally strongly in both autumn and spring, and sometimes in winters. And then it consolidates during the summers. But in the summer of 2011, an extraordinary event short-circuited this ironclad seasonal tendency. The rancorous debt-ceiling debate in Washington was pushing the United States to the brink of technically defaulting on its Treasuries, creating unprecedented uncertainty risks.

So American investors piled into gold with a vengeance, not sure what would happen to interest rates, bond prices, and the US stock markets if some agreement wasn't reached to address Obama's record overspending. In just 7 weeks in the heart of summer, a time when gold is virtually never strong, its price rocketed up 27.4%! Much of that rally was driven by stock traders pouring capital into the GLD gold ETF.

Its holdings surged by nearly 85 metric tons (2.7m ounces) over that short timeframe, its custodians forced to shunt excess GLD share demand into physical bullion to prevent this ETF's price from decoupling from its underlying asset to the upside. But the resulting gold surge was vertical and euphoric, this metal had soared 44.4% in just 6.8 months! By late August 2011 it was very overbought, it had simply surged too far too fast to be sustainable.

If you want to know who to trust for market advice, a simple test is to see what they were saying at known past extremes. And August 2011 was one. Greed ran rampant in gold while analysts universally called for a continuing acceleration higher. There were few contrarians rightly calling for a major correction, and I was one of them. One trading day before gold peaked, I wrote an essay declaring gold overbought and due to correct.

And boy, correct it did! As a speculator I've never liked vertical surges that get other traders too excited. Why? They pull buying forward. Traders who would have bought gold in the following months rushed to get in so they didn't miss the boat. Naive traders succumb to the hype and buy high, and naturally they are psychologically crushed when their "sure thing" bet immediately crumbles right before their eyes.

The combination of all upcoming buying sucked in and tremendous sentiment damage to those who foolishly buy high near peaks results in much longer and deeper corrections than normal after serious greed-laden spikes higher. And gold indeed corrected for a long time after its euphoric vertical surge in the summer of 2011. It didn't ultimately bottom until May 2012, 8.8 months later after this metal had lost 18.8%.

That whole correction resulting from the frenzied USA-default-fears buying created a giant technical formation known as a descending triangle. This is a bearish formation because downward momentum is building and demand weakening. But there is one critical exception. When the inevitable breakout from a descending triangle is an upside one rather than the usual downside one, it is a very bullish omen.

But before we get to gold's upside breakout, let's consider gold's major bottoming last summer. During that capitulation selloff culminating in mid-May that ended gold's correction, this metal fell to wildly oversold levels. Just like overboughtness means a price has risen too far too fast to be sustainable, oversoldness means a price has fallen too far too fast to be sustainable. My favorite way to measure this is Relativity.

Many years ago I developed a trading system I called Relativity. It looks at a price relative to its trailing 200-day moving average. This forms an objective baseline from which how far and fast a price moves can be empirically measured. When a price is divided by its 200dma, over time it forms a horizontal trading range. In gold's case, it has been overbought when it stretches more than 25% above its 200-day moving average.

Back in August 2011 after that euphoric vertical surge, this rGold indicator had hit 1.286x. Gold had soared so fast that it was 28.6% above its 200dma, one of the most extreme levels of its entire secular bull! That was one key reason why I knew to fight the crowd and call for a major correction right at gold's peak in August 2011. Overbought prices soon correct, right after extreme rallies suck in all near-term buyers.

But by May 2012 after that massive correction, gold was very oversold. Fear had grown so great that this metal was trading at just 0.907x its 200dma. As the next chart will show, the only other time gold had been driven to such extreme lows was during 2008's epic once-in-a-century stock panic. So gold was due for a major new upleg, although the poor summer seasonals suggested it would have a slow start.

Though this metal started climbing and carving higher lows immediately after last May's capitulation, it didn't really start moving until late August. Just before that when the vast majority of traders and analysts remained overwhelmingly bearish on gold, I wrote another contrarian essay calling for a major new upleg. The impetus was excessive bearishness in gold futures that occurs just before major uplegs erupt.

And indeed gold soon started surging in late August, decisively breaking out to the upside from its long descending-triangle correction. Soon after that it blasted back above its 200dma, another milestone seen early in new uplegs. And as first the European Central Bank and then US Federal Reserve announced unprecedented new open-ended inflation campaigns, gold accelerated dramatically in September.

That sharp rally was super-profitable and confirmed beyond any doubt that a major new upleg was underway. But unfortunately, it was too fast. Though gold only rallied 16.4% in 4.6 months, minor within the context of this secular bull, it was overbought on a short-term basis. So this metal started to pull back in October. Such pullbacks are perfectly healthy and normal within ongoing uplegs, they rebalance sentiment.

That pullback coincided with a typical period of seasonal gold weakness in October after its big seasonal strength in September. So it wasn't the least bit worrying. But when gold failed to rally in November for a variety of atypical reasons, traders started to get worried. And when that slump accelerated in December despite the Fed greatly expanding its QE3 debt-monetization campaign, real fear started to creep in.

I cover gold's daily price action in great depth in our popular newsletters, so speculators and investors can better keep everything in context and understand the causes and effects driving gold. So if you are interested in staying abreast of why gold is moving and what is driving it, you ought to subscribe. While a full explanation of what happened to gold in recent months would take far too long for this essay, here's a summary.

The Federal Reserve's debt-monetization campaigns, euphemistically called quantitative easing, are highly inflationary and thus wildly bullish for gold. But gold futures traders often ignore all gold's other fundamentals, focusing exclusively on QE. Thus whenever a major economic report comes in better than expected, they sell gold in the belief that an improving economy will stay the Fed's hand much sooner.

Gold's big initial selloff in early November was driven by this dynamic after a better-than-expected monthly US jobs report. Other down days in recent months were driven by other better-than-expected economic data. By late November and early December, worries about the coming fiscal-cliff tax hikes ran high. They would be the biggest tax increase ever seen in the history of the United States of America!

If nothing was done, investment taxes would have nearly tripled! So affluent investors rushed to sell all kinds of positions before the lower 2012 tax rates expired. They asked hedge funds to return their capital, so they could realize their gains and sit in cash. This led to large redemption requests which some funds helped meet by selling their liquid gold positions. This weighed on gold despite the expansion of QE3.

And then in early January after the fiscal-cliff tax hikes were largely averted, there was a gold scare from the FOMC's meeting minutes. CNBC, in its rush to report on the 7500-word minutes from the FOMC's December meeting where QE3 was expanded, erroneously claimed the Fed thought QE3 would end way early. The truth was only a small minority of FOMC members expected that, but the headlines still crushed gold.

The collective result of all this was the gold slump between early November and early January. And since then, gold has stabilized but is still languishing. Of course since the fiscal-cliff tax deal was made, the stock markets first surged and then edged to a long series of new cyclical-bull highs. This made the stock markets very attractive and stole investors' attention away from everything else including gold.

Gold has always been an alternative investment, and alternatives are simply ignored and forgotten when the primary general stocks are doing so well everyone is enamored with them. Thus gold has been consolidating in recent weeks, biding its time until the stock markets inevitably roll over due to extreme complacency. And that brings us full circle to today, the necessary context to understand gold's drift.

Despite those headwinds, take another look at the gold chart above. Ever since gold's massive correction ended last May, this metal has been marching higher on balance. It has achieved higher highs leading into early October, and higher lows since. Gold has carved a beautiful support line that shows its young new upleg still very much alive and well. The metal has merely pulled back and consolidated to this support!

Now this week of course gold broke below support, but I wouldn't read too much into it for a couple reasons. First, as the correction's support line shows it isn't uncommon for prices to make brief forays below support. Second, this week's weakness is happening in a low-volume time when key Asian markets are closed for the entire week for Lunar New Year celebrations. Gold trading is far from normal without Asian participation.

So for all intents and purposes, gold's 200dma is effectively holding. This is another attribute of uplegs, within them 200dmas become support. Gold's young upleg is very much intact, and at this week's seemingly hopeless levels remains way above last May's $1530s from where this upleg was born. Gold is also oversold today in Relativity terms, trading at just 0.987x its 200dma. Such levels are very bullish.

With gold's young upleg looking fine, it will be interesting to see what happens in the coming weeks as the gold-loving Asians return to the fray. But in the meantime, consider an even bigger perspective to frame the recent discouraging gold action. This chart zooms out to encompass this metal's secular bull since 2007. Far from being low today, gold is actually consolidating high which is a major show of strength.

Relative Gold 2007-2013

After surging in late 2007 and early 2008, gold got very overbought and consolidated high (much like today) before that once-in-a-lifetime stock panic sucked it in. Between its panic lows and its latest bull highs in August 2011, gold blasted 166.5% higher in just 33.3 months! After that massive bull run, a big correction was definitely in order. And that is exactly what we've seen since late 2011, a normal and healthy event.

Provocatively by the time that correction bottomed last spring, gold bears were arguing that the secular gold bull was over. But secular bulls don't end with prices consolidating high, instead they climax with prices collapsing after a popular-mania parabolic blowoff. The fact that gold prices have remained high since summer 2011, with gold barely surrendering any of its secular bull's gains, virtually guarantees there is more to come in its bull.

Instead of a post-secular-bull collapse, we've instead got a giant high consolidation forming a symmetrical triangle. These formations are known as continuation patterns, they are temporary respites within the primary trend. And for gold that is up. Gold entered its symmetrical triangle from the bottom, and is thus highly likely to exit through the top as this young upleg accelerates. That will be soon, as this triangle is almost closed.

After gold's last consolidation in 2008, it powered higher dramatically for years to come afterwards. And it was nearly as extremely oversold when this latest correction ended as it was during the stock panic. So not only will this current upleg push gold to new bull highs, this next run higher is likely to be large and long-lived after such an extended consolidation. You could hardly ask for more bullish gold technicals!

At Zeal our decades of trading experience have taught us to keep things in proper perspective, to fight the tyranny of the present. Thus we are able to buy low when few others will touch a sector, and later sell high when everyone is hot on it. And this secular gold bull has been our bread and butter, with precious-metals stocks dominating our past decade's trades. Since 2001, all 637 stock trades recommended in our newsletters have averaged annualized realized gains of +33.9%!

If you want to follow gold's action in detail, to understand why it is moving and when to buy and sell, subscribe to our acclaimed weekly and monthly newsletters. In them I apply our decades of experience, knowledge, and wisdom to understanding this gold bull as well as the general stock markets. With the right perspective, you will never get greedy and never get scared. So you can buy low, sell high, and earn a fortune. Subscribe today!

The bottom line is gold remains in a young upleg today despite the recent months' vexing slumps and drifts. It has carved higher lows and higher highs despite the adverse sentiment environment, its current trend is definitely higher. While traders are all caught up in how crappy gold has felt in recent weeks, the bigger picture is far more bullish than most give gold credit for. Maintaining perspective is utterly crucial.

With traders being fed up with gold and very discouraged, and it being very oversold, this metal is overdue for an imminent major rally. Some catalyst is going to arrive very soon that will spark serious buying as gold shorts rush to cover their positions. Maybe it will be the US stock markets rolling over, maybe it will be Europe woes, maybe it will be something else. But technically gold is due to surge.

 

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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