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February 07, 2003

Golden Bull Buy Signals
by Adam Hamilton

What a fantastic year for gold thus far! The Ancient Metal of Kings continues to gallop higher after utterly obliterating the $325 Maginot Line fortifications and leaving their still smoldering hulks far behind over the horizon.

For the hardcore contrarian investors who have been long this awesome gold bull since the beginning, it is a wonderful blessing to see gold actually within spitting distance of the fabled $400 levels! Less than two years ago the noble metal had been beaten way down to near $250 and the mainstream investment world considered it to be officially dead.

It is fantastic to see gold make fools of the naysayers and vindicate the contrarians! If you were investing in gold and gold stocks a couple years ago near the bottoms, you certainly remember the endless scorn heaped upon us by the mainstream. Gold and gold stock investors, who look like geniuses today two years later, were treated as untouchable outcasts and infectious lepers, utterly shunned near the bottoms. Back then believing in gold was the kiss of death in financial social circles.

Thankfully though, today the once smug Wall Street perma-bulls are gradually becoming contrite, salvaging whatever remaining shreds of their once great capital they can manage, and slowly joining the growing ranks deploying their capital in the next major investment wave for this decade in commodities. We contrarians are used to being the maverick black sheep and we don't hold grudges, so we happily welcome them aboard.

The former tech-bubble zealots now deploying capital in gold and gold stocks are the early vanguard that will ultimately lead the thundering herd of mainstream investors to gold in the coming years. As contrarians we need the mainstream to catch on sooner or later so their vast collective pools of capital can ultimately bid up gold and gold stocks to fantastic heights scarcely imaginable today.

While dazzling visions of a future gold bubble and unimaginably massive profits dance through contrarians' heads, those euphoric gold-bubble days are still most likely a few years or more into the future. The pressing matter at hand today is gold's near-term behavior, especially with the probability of Washington, DC's attempted annexation of Iraq approaching certainty.

With investor anxiety running high as we sadly approach the devastation of war, it is an important time to discuss the near-term technical picture for the Ancient Metal of Kings itself as well as its most popular highly-leveraged proxies, the unhedged gold stocks. In addition, a rock-solid potential buy signal is emerging on the technical gold and gold-stock charts which may prove immensely profitable to heed after any war-induced pullback.

As with any journey, before we discuss this particular detailed technical section of our travels it is important to gain a quick perspective on the entire strategic voyage to date, from whence we came to get here.

Our first graph this week deviates a bit from the usual Zeal fare. We have a giant "Gold and Gold Stocks" graph we use internally to monitor both the progress of the new gold bull as well as the interaction between gold and both unhedged and hedged gold stocks. Unfortunately the large graph doesn't condense well into this much smaller essay graph format.

While we tried several different ways of presenting this crucial strategic perspective, the best way proved to be merely shrinking the giant graph down 60% or so to the smaller essay size. While you can't read all the numbers on this shrunken graph, you can see trends and understand the road we have traveled. You are also welcome to go grab a free copy of the crystal-clear original giant version at www.zealllc.com/2002/gold.htm if you wish to follow along.

In this graph, the yellow data is the price of gold and the black lines are its trendlines over the past 7 years or so. The red line is the heavily-hedged XAU gold-stock index and the blue line is the soaring unhedged HUI gold-stock index. The graph runs from 1996 to the present, its left axis marks gold from $250 to $450, and its right axis gauges both gold-stock indices from 0 to 200.

Just when things seemed the bleakest back in late 2000 and early 2001, both gold and gold stocks bottomed with no fanfare and started stealthily marching higher under the radars of the vast majority of market players. The trend since those dark days for gold and gold stocks has been aggressively upwards. Gold's bottom and its subsequent assault on wondrous highs not witnessed for more than 6 years is readily apparent above.

On the right side of the graph our enormous current rally in gold blasting it up to new highs around $375 is quite apparent. It is crucial for the sake of perspective to fully realize that the whole move from under $325 to today's awesome heights transpired since early December. In two short months, truly a blink of the eye in the grand scheme of the markets, gold has accomplished what most thought was impossible not too long ago.

Gold's current mega-huge breakout rally has swiftly carried it up over $50 in a spectacular move that looks nearly vertical on a long-term gold chart. Nothing even remotely like this has been witnessed since the sharp Washington Agreement gold spike in late 1999, although the character of this current major gold rally is vastly different from the strange events of three and a half years ago. Today's rally was not a blistering spike over a couple of days but a powerful upward surge over months produced by heavy global buying.

I wanted to share this long-term strategic perspective on gold with you before we get into our current short-term technical analysis for two important reasons.

First, today's gold investors are witnessing a very special event for which we should be very thankful. For you fellow battle-scarred contrarians who were also there at the bottoms a couple years ago, it should bring tears of joy to your eyes to realize how far we have been blessed to saddle up and ride this mighty golden bull already, and the best is yet to come! The events of the last two months are very different from anything else witnessed for decades and they cannot be considered "normal", at least in the context of gold's recent past.

Second, as every contrarian speculator knows, no market ever moves straight up or straight down indefinitely. With such a powerful move for gold condensed into such a short time frame as readily evident in the graph above, it does seem prudent to steel ourselves for an inevitable pullback in gold and gold stocks.

Pullbacks are entirely normal and healthy in major bull markets and should be expected and embraced as wonderful opportunities to "buy the dips", as our tech friends used to prudently say before their bubble burst. Short-term pullbacks are necessary to relieve temporary overbought conditions and graciously grant new entry points for fresh capital, as well as lay the foundational groundwork for drawing in ever increasing numbers of investors.

A powerful bull market requires a slow, steady march northwards in spectacular rallies and then sharp pullbacks to ultimately seduce the greatest amount of capital possible to bid on the market and drive up prices. If gold is indeed to run to the $5000 range as I suspect before all the dust settles on this new gold bull in coming years, it needs to run up as cautiously and methodically as possible at first. Each pullback offers the golden bull a crucial feasting opportunity to gulp down more fresh capital which feeds it the energy necessary to gallop aggressively to new highs in the next major upleg rally.

As you ponder the short-term technical pictures presented below for both gold and gold stocks, please realize we have traveled quite far quite fast and that the big strategic picture suggests it is prudent and reasonable to expect a pullback and some consolidation at some point along the line. Don't fear the pullbacks though, instead embrace them as awesome buying opportunities!

While some folks believe technical analysis is mystical and difficult to understand, at the basic level it is actually quite simple. If way back in grade school you could handle "connecting the dots" to draw pictures in those fun kids' coloring books, then you will excel at the similar "child's play" of basic technical analysis.

All you have to do is print out any price chart and start connecting the dots. Piece of cake! In a bull market as we are blessed to be witnessing in gold, your first step is to draw a straight line connecting as many bottoming points on your price chart as possible. This first straight line is called a "support line", because visually the price is "supported" when it trades near the line and bounces higher.

After that, you visually analyze the rally peaks in your price graph and you look for a place to draw a second line that connects as many of the tops as possible. This second line must be parallel with the first. This second line connecting the tops is called a "resistance line", because when the price gets near this line it seems to encounter fierce resistance and it sells off and heads lower.

Together the bottom support and top resistance lines you drew form a "trend channel" or "trend pipe". When the slope of this channel is upwards, you are witnessing a bull trend. Conversely when it trades downwards, you know you are in a bear trend.

There is absolutely no reason to be intimidated by basic technical analysis as it is incredibly easy and anyone can do it anytime.

In the gold graph above, which coincidentally shows the entire gold bull to date, there have essentially been two uptrend channels. The initial channel is drawn in white and the new channel is drawn in blue. The first channel gave way to the more bullish second channel in early 2002, near the blue fulcrum point in the graph. Since I have discussed the first channel in white many times in past essays, I want to focus your attention on the new blue channel this week.

The latest gold breakout, from its new uptrend channel, is marked with the blue X above. Interestingly, it happened rather shortly in time after its breakout from its initial uptrend channel around the $325 Maginot Line marked by the white X. These double breakouts of the initial and new uptrend channels so close together farther cement the idea discussed above that something special and unique has transpired in gold in the past couple months.

Interestingly, after gold broke out of its new uptrend channel under $350, there is some visible sideways-upward congestion in the price of gold. This is highlighted in blue above. Often times this type of congestion activity occurs on technical trend lines which suggests a couple insights.

First, it provides an important additional confirmation that the new uptrend channel is valid since this type of price action is expected near major trend lines like the new top resistance line. Second, it suggests that other technical analysts are seeing the same uptrend in their own analytical work and the choppy behavior near the resistance line probably represented indecision as they tried to decide whether to buy or sell on the latest breakout.

This congestion zone at the new resistance line provides strong evidence that gold's technical trend channel has indeed favorably shifted and is now sloped more steeply upward, a wonderful harbinger of growing strength in this magnificent new golden bull.

I found myself awestruck by a different aspect of the graph though, which could prove extremely valuable for gold investors and speculators moving forward. Please examine the black 200-day moving average line for gold above as it may be immensely important. It not only provides anchor points for trend channels but may even signal nearly perfect buying opportunities after normal healthy pullbacks.

Gold's black 200dma above has proved to be uncannily parallel with the lower support lines of both its initial and new uptrend channels! The trend lines above were drawn based solely on gold's price, yet its 200dma has usually meandered right where the lower trend lines happened to fall. This fascinating convergence of the 200dma of gold and its lower support lines will help investors discern the proper trend channel slope as the gold bull continues to unfold in the future.

As an active speculator, I am really excited to see that gold's 200dma has never been significantly pierced to the downside in gold's whole rally to date! Every single major pullback in gold has done no worse than drag it back down to its 200dma, which currently stands a little below $325. This is fantastic news for speculators, who are always diligently searching for patterns that may be tradable.

In the next gold pullback, which will probably be sharp and terrify lots of folks, gold's moving averages may provide the crucial buy signals to get back in near the pullback low in time to ride the next strong upleg rally.

If gold plunges all the way back down to its 200dma, around $325 today, as well as its red 50dma line shown above begins to converge with the 200dma, it is time to buy back in with zeal. This signal has proved rock-solid for the whole gold bull thus far and could prove to be very useful for gold investors who are stopped-out on a pullback or simply wish to advantageously deploy more fresh capital into gold and gold stocks as the golden bull marches on.

The price of gold relative to its 200dma, especially in these early stages of the bull before the general public bids it into a vertical mania-stage bubble like in 1979/1980, may just prove to be the ultimate buy signal to mark the bottom of any major pullbacks. If you are stopped out, look to the 200dma as a primary and the 50dma as a secondary buy signal to redeploy back into gold to continue riding the mammoth gold bull.

The 200dma also provides valuable clues as to how far gold could actually plunge in a normal healthy pullback, in this case all the way back down to the old $325 Maginot Line. If this indeed happens in the coming months, I can guarantee you that the majority of gold investors will be terrified and there will be blood running in the streets. This is the perfect short-term contrarian moment to buy back in!

Interestingly, the 200dma buy signal as well as the uptrend channel confirmation work just as well with the HUI unhedged gold-stock index.

The 200dma of the unhedged HUI gold-stock index has exhibited the same fascinating behavior as gold's 200dma. In the graph above it is readily apparent how both the initial and steeper new uptrend channels in the HUI had bottom support lines that precisely paralleled its 200dma. Once again the 200dma provides a strong secondary confirmation of the validity of a given uptrend channel drawn in by a technical analyst.

More exciting however, note that the HUI, like gold, also has never significantly pierced its 200dma to the downside in the whole bull market to date! Each time the HUI traded close to its 200dma, a spectacular rally upleg ensued and catapulted the unhedged gold mining stocks far higher.

Both gold-stock investors and speculators should carefully watch this HUI 200dma very closely to determine optimal entry points to buy back in if they are stopped out in a pullback or if they have fresh capital they wish to deploy in the future. Just as in gold, the interplay between the HUI's 200dma and its actual price could be the ultimate buy signal to date in this spectacular gold-stock rally.

As a real-world acid test of this idea, we purchased and recommended two gold stocks in both early November and early December for our Zeal Intelligence subscribers. As the November 2002 Zeal Intelligence newsletter was published the HUI closed at 111, exactly at its 200dma, so we purchased some elite stocks. The two gold and silver stocks we bought then are currently blessed with unrealized gains of 44% and 45% as of the end of January.

One month later the same strong buy signal miraculously reappeared, so we also bought and recommended two new leveraged gold-stock plays in the December issue of ZI for our subscribers. The HUI was trading at 116 while its 200dma was at 115 as this newsletter was published. These second two gold stocks are thankfully now up 49% and 63% as of the end of January, not too shabby.

These 200dma buy signals in gold and the HUI are not only interesting academically, but they are powerful and are working delightfully well in the real world. Gold investors and speculators should carefully monitor the price of both gold and the HUI relative to their respective 200dmas all the time, but especially during any normal bull-market pullbacks.

Incidentally, for our gold-oriented subscribers the just-published February 2003 issue of Zeal Intelligence discusses two important issues many gold investors and speculators are agonizing over today.

In the newsletter I offered my thoughts on the distressing perception that gold stocks are dramatically lagging gold. I also discussed the question of actively trading the gold bull or simply buying-and-holding it, another area in which we have been receiving a blizzard of inquiries lately. In addition, the current status of the 4 newer 200dma gold and silver stock trades mentioned above is also outlined.

If you honor us with a $59 annual newsletter subscription to support our ongoing research work, you too can be reading your complimentary copy of the shiny new 2/03 ZI this afternoon!

Because gold and gold stocks have run so far so fast in recent months, and gold is far above its new uptrend channel, and gold-stocks are bumping the top resistance line of their own new uptrend channel, I believe it is reasonable to expect a healthy pullback in the coming months. This pullback could conceivably drag us all the way back down to the 200dmas, today around $325 on gold and 125 on the HUI. This will be terrifying for gold and gold-stock investors not expecting it, but for those who are the buying opportunity will be immense at the next interim low.

I suspect the "excuse" for the pullback will be Washington's invasion of Iraq. For some reason many professional futures traders today have not done their homework and believe that the whole gold rally is merely a war-hedge play.

They somehow overlook the fact that the gold bull has been marching relentlessly northward for two years and gold stocks longer than that, well before 9/11 or imperial Washington's crazy crusade to invade practically every sovereign third-world country on Earth it disagrees with, legitimate Constitutional casus belli be damned.

As the immensely wise ancient Chinese military philosopher Sun Tzu wrote millennia ago in his magnificent magnum opus "The Art of War", "All warfare is based on deception."

Because war is based on lies, monopolizing information flow and distributing feel-good propaganda is crucial for any war effort. Since Americans, even patriotic ultra-right-wing conservatives like me, are divided 50/50 on the dubious wisdom of invading another sovereign nation for no good reason, the Bush Administration has an uphill job and will make sure the early war news is good so Washington's rapidly eroding public support in the States doesn't completely vanish.

Since Washington, DC will totally monopolize all information flow in its upcoming Iraq invasion, we are guaranteed that all early war news will be glowingly positive regardless of what is really happening on the front. The large futures traders will take the US government's good-news propaganda at face value as gospel truth and will probably sell gold and oil hard.

They will assume the gold bull is dead because the Iraq war is on, but they will almost certainly be wrong. Primary bull markets in gold this powerful run for many years or even a decade historically, not just a couple.  This gold bull has nothing to do with wars and everything to do with fundamental underlying structural economic factors.

Nevertheless, their concerted selling action on the initial good Iraqi war news from Washington, be it truth or propaganda, will probably be the cover under which the overdue and inevitable gold pullback arrives. While it will certainly be frightening and sickening to watch for investors with large capital deployments in gold and gold stocks, have no fear. Even if you are stopped-out you can then patiently watch the gold and HUI 200dmas for ideal buy signals to jump back into the fray near the next interim bottoms.

While the prospect of a gold pullback is no fun for those of us already heavily invested in gold and gold stocks, we can prudently steel ourselves to expect the coming squall and ride it out with minimal discomfort.

Even better, like a stunningly beautiful rainbow after a wicked hailstorm, the tantalizing possibility of a fabulous 200dma gold and gold-stock buy signal being triggered after the pullback is a really exciting prospect that could prove to be immensely profitable.

Adam Hamilton, CPA
Zeal LLC.com

Do you enjoy these essays? Please help support Zeal Research by subscribing to Zeal Intelligence today! &www.zealllc.com/subscribe.htm

If you have questions I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/financial.htm for more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I WILL read all messages though, and really appreciate your feedback!

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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