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GOLD COOLS OFF
Chris Temple
Even as stocks have slowly unraveled again and oil prices remain strong, gold has plunged since hitting a frothy intra-day high of just over $390 per ounce a mere two weeks ago. As you know from some of my previous comments, this really comes as no surprise. Activity in both the gold area as well as the currency markets had become stretched too much, too fast. Further, gold stocks as a group were failing to confirm gold's spike as anything other than a short-term trading phenomenon. The long term trends favoring gold versus the dollar seem to be for real. But it had become unmistakable that, at $390, gold had become overbought, heated up by a rush of short-term speculative money that at one point recently saw the open interest on the COMEX rise to a record.

When I wrote my February 12 update for subscribers, gold was trying to hold the fort above the $350 per ounce area, the approximate level of its 50-day moving average. As I write this update on Sunday evening the 16th, gold is off sharply in early overseas trading, and could quickly test the $340 area.

Few argue that the longer-term fundamentals for gold remain strong and quite in tact. But as one trader, HSBC Bank USA chief bullion dealer Robert Gottlieb said this past week, "Although the dynamics of the markets may look like the price should be up -- with the stock market down and the bin Laden tape -- the positions in the market are bigger than the dynamics." The positions Gottleib referred to are the massive number of call options short-term traders have bought in recent weeks, betting that tensions over Iraq, a declining dollar and falling stock markets would keep the party going. Simply put, hedge funds and other traders chasing gold's momentum had all piled into the same side of the boat, so to speak. Now, they are unwinding these positions even if longer term, as Gottleib suggests, the dynamics still favor gold.

In addition to gold simply having become overbought, the events of the last few days have removed at least some of the urgency of owning it. It turns out that at least some of the claimed reason for us going to a "Code Orange" on the terrorist threat hit parade came from an al-Qaeda prisoner who subsequently failed a lie detector test. In addition, the Hans Blix/Mohamed ElBaradei dog and pony show at the U.N. Security Council meeting last week raised some new doubts about just how quickly military action by an increasingly isolated U.S. against Iraq might occur. The "kicker" adding to gold's woes was a sharp technical Valentine's Day rebound on Wall Street; perhaps amorous traders thought that a welcome boost to their sweethearts' portfolios might increase their chances for intimacy.

All these things, of course, could prove transitory. Eventually, in fact, they probably will. President Bush will not be easily deterred, and still claims that-even though a new U.N. resolution is rumored to be in the works-he simply doesn't need one. Friday's rally could prove to be yet another blip. North Korea might give us the willies again. Take your pick; but for the instant, things have moderated sufficiently as to be causing this sell-off in the yellow metal.

Barring any further sudden changes in the near-term geopolitical outlook, gold traders will chiefly be watching to see if gold can hold a series of real or perceived support levels. At this point, all the players in the market care about is technical levels; and this breach of the $350 per ounce area could well see us move down to $340. That level is as much psychological as anything, however. The key test for gold will come if and when the metal sells off down toward the $325-330 area.

This level is important for two reasons. First, as you no doubt recall, it provided the greatest resistance during the second half of last year, as gold was on the rise. Therefore, it will be viewed as, hopefully, just as stubborn on the way back down. Second, this level is where gold's 200-day moving average is now at, making the $325-330 area doubly important.

As I mentioned above, one way to tell that the last part of gold's spike wouldn't hold was that gold mining shares were still badly lagging the behavior of gold itself. (Here's another hint for those of you who follow the price closely-both the April and June contracts for gold also confirmed that the move to $390 would hold, as prices for both those contracts were below the cash price.) Gold shares as measured by the AMEX Gold Bugs Index (HUI) have still not been able to move above their June, 2002 highs, back when gold was at just under $330 per ounce. Now, the HUI has already broken its 50-day moving average, and could-as gold-shortly be testing anew its 200-day moving average.

As I have so often said, understanding the gold market requires one to look at it calmly, coolly and without listening to the often hysterically bullish prognostications of some. In my January commentary, I said that I felt gold would carve out a new, higher trading range before 2003 was over of between $350 and 380 per ounce, removing the increased gyrations that were inevitable given the dicey geopolitical situation. This is based on my view that gold's longer-term fundamentals were (and are) still essentially in tact. And they most certainly are.

As gold quickly moved into that area, I was amused to receive a few e-mails from those reading my commentaries in this newsletter, on Kitco and other web sites essentially saying, "You missed the boat, wise guy! Gold's going to the moon!" Eventually, it may well do so; and I remain quite confident that gold shares, in spite of their current sell-off together with gold, will be long-term winners. But once again, we've seen what can go wrong from time to time, especially when we invest with our hearts and emotions rather than with our heads. And I'll say it again: this correction could be spotted a mile away.

What's good about this for those of us who pared back our exposure at gold shares' peak last year and have limited ourselves to only our long-term "core" position in the gold area is that, lying ahead of us, will be the second best opportunity to take major positions in the gold sector; second only to the Fall of 2001 as gold was beginning its new bull market. We're getting closer to that; and, perversely, I wouldn't be all that upset if gold did indeed soon threaten the $325-330 area. After all, this would bring with it more of a blow-off in gold shares, especially for those junior producers and most promising exploration companies that may well lead the next broad charge ahead. Frankly, I'd like nothing better than to see continued gold and gold stock weakness in the days ahead embolden the bears, who are already re-writing gold's epitaph, and will do so more energetically. This simply means more of a correction, lower entry/re-entry points shortly ahead, and even bigger profits when Wall Street wakes up to the fact that, just as the bear market in stocks would be occurring with or without the help of Saddam Hussein so, too, would the still-young bull market in gold.


Chris Temple, Editor
National Investor
www.nationalinvestor.com

20 February 2003