Gold Breaks Out - Or Does it?

Until today, gold’s behavior had been exasperating of late. Its trading range has incrementally narrowed in recent weeks, and even more so in recent days. As one analyst termed it late last week, it seemed as though the ongoing battle between gold’s bulls and bears had entered the hand-to-hand combat stage. One minute gold seemed sure to be ready to break above its overhead resistance, only to falter. The next, it seemed as though a shake-out was coming-but then physical demand again materialized in the $358-360 per ounce area, and the metal was able to stay above its rising line of support.

Encouraging signs have come from gold’s ability to keep most of its latest gains in tact in spite of a rally in the U.S. dollar. This and seemingly stronger fundamentals have encouraged the bulls; in addition, geopolitical worries from the Middle East to India have added support. As a result, going into today, net speculative long positions on the Comex had surged to a record; and positions were added to aggressively today.

Keep in mind that, as I have written a few times lately, gold’s activities are still ruled largely by short-term traders. One reason for today’s action, in fact, is that some options contracts for August were expiring. It appears that at least some of the impetus for today’s surge was many of the same speculators who had expiring contracts, say, at a gold price of $365 or $370 goosed a thin market higher so as to exit the older positions at a better level. This is reason to give us a little worry that today’s break-out could turn out to be a temporary wonder. Without a strong follow-through, we could just as quickly see the record net long position unravel, if many of these same traders see gold’s recent good technical behavior fading.

Some comments over today’s trade also centered on speculation that, at next month’s I.M.F. meeting in Dubai, we might see a renegotiation or extension of the 1999 Washington Agreement where 15 central banks agreed to limits on their annual gold selling and leasing activity. That could extend and keep transparent the supply coming to market from this source and-unless central banks decide to unload significantly higher quantities starting in 2004-be another bullish development for the market.

As I’ve said recently, I’d feel better about the gold market-and the current pricey level of gold shares-if there was more evidence that stronger, longer-term hands were a bigger factor in the market. They still are not-at least to my satisfaction. Thus, we need to watch gold and gold equities VERY closely in the coming days to see that it maintains its upward momentum. If gold is sooner rather than later able to move above late May’s high of $378 per ounce with any conviction, another $20 could quickly be tacked on. At the first sign of a loss of momentum, however-and especially if we start to see an unwinding of the record net long positions-we’ll want to cut back our exposure to the sector temporarily. For now, keep to your 15% portfolio weighting in gold shares.

STOCKS-CALM BEFORE A STORM?

With the most notable exception being yesterday’s 100+ point swing in the Dow, stocks have in recent days behaved as they typically do late in the summer. Most days have been marked by fairly directionless trading. Stock prices are almost paralyzed by a combination of light volume, bears too afraid to short against the momentum of a five month rally, and bulls’ blind hopes of a strong economic recovery being tested by high energy prices, a queasy bond market and a continuing loss of jobs.

Most people will be ignoring the last two days of the week which will likely see even lighter volumes. They will not, however, be ignoring the annual Jackson Hole, Wyoming confab, hosted by the Kansas City Fed, which gets underway tomorrow. There, Fed Chairman Greenspan (a veritable hermit of late otherwise) will give the Friday morning key address. Last year, he dealt with criticism of the Fed’s fueling of a stock market bubble in the late 1990’s. Among the things he’ll no doubt hold court on this year (whether he likes it or not) is how the Fed so whipsawed the bond market as to cause a sudden surge higher in long term interest rates over the last couple months.

Nobody necessarily expects any reports from this invitation-only meeting to immediately move the markets. Key to watch in the coming days regardless, though, will be a still-skeptical bond market. Importantly, Treasuries over the last few weeks have managed to stabilize, taking at least some of the pressure off overpriced stocks for now (though higher rates have hit new mortgage and refinance applications hard.) Watch the 10-year note: any move back above the 4.6-4.65% area that was the high in yields following the summer sell-off will hasten the inevitable correction for the stock market.

Better signs of the short-term outlook for stocks will come next week, once most folks’ summer vacations have ended and normal trading volumes resume. I am still firmly convinced that the market is long overdue for a sizable correction, for all the reasons I have previously covered. Whether we get one final spurt higher before that remains to be seen next week.

For now, I have no immediate changes to either current asset allocation recommendations, or to my recommended list of holdings.

-Chris Temple
www.nationalinvestor.com
August 29, 2003

(NOTE: Chris has just completed a comprehensive update on the gold sector which, among other things, includes a look at gold’s fundamentals, investment demand, the future monetary role of gold, how to select viable gold companies for investment/trading purposes and more. As an introduction to The National Investor, he’s offering a FREE COPY to our readers; to get yours, send a request via e-mail to chris@nationalinvestor.com.)