HUI: Major upswing in the making?
Part II
Eric Hommelberg
May 14, 2006
On May 12 we send out an HUI alert to our members suggesting that due to the Gold/HUI divergence a major HUI upswing couldn't be ruled out. Well, exactly the opposite happened and the HUI sank like a stone dropping 18 pts…Does it change my HUI outlook? No, not really, it only strengthens the thesis that the Gold/HUI imbalance has reached an extreme that has to be resolved rather sooner than later..Such an imbalance can only be resolved by a major HUI up-swing or a fast dropping gold price. Although the gold price did came down on Friday May 12 it sure wasn't a convincing drop and to me it seems that pushing down gold in an environment of increasing dollar weakness (dollar failed to recover on slight improved trade balance numbers), rising oil prices, the current US-Iran stand-off and the on-going short cover (gold continues to rise while the open interest continues to drop) is like trying pushing down a ball under water. It will work out for a short period of time but eventually it'll pop up violently.

Jim Sinclair, one of world's leading gold authorities told his readers on May 12:

The question you are asking today is if the rally in gold is complete. The answer is NO. The price of gold has internal probability favoring a push into the 800s on this leg of the Great Gold Bull Market of the Millennium. This is all I really need to write today as this is all you really want to know. END.

So if Jim Sinclair is right the odds are that we won't see a major correction in gold as from this point so in order to resolve the Gold/HUI imbalance we should expect new HUI highs anytime soon.

Let's take a peek at the updated Gold/HUI charts and comments from May 12:

Ever since the HUI break-out of 250 early December last year I maintained the view that this move could be a similar one as the one we've witnessed in 2003 thereby launching the HUI towards the 430 mark! See eg: www.gold-eagle.com/editorials_05/hommelberg030506.html

Now the HUI failed to respond lately to the dramatic rise in gold. Some may argue that this forebodes a correction in the yellow metal itself, some say that gold shares are overvalued anyhow.

Now what about the shares vs gold, is there any correlation? What should be the correlation? Is the HUI lacking indeed?

Some analyst argue that there isn't any correlation between gold and the HUI at all.. I'm not going to waste my time on such nonsense since the chart below tells it like it is. There's a strong correlation indeed between rising gold prices and the HUI.

Now that we know that there's a strong correlation indeed why hasn't the HUI catch up on gold lately?

Well, although there's a strong correlation indeed that doesn't mean that the HUI should track gold on a one to one basis… What I mean to say is that sometimes the gold shares are a bit too enthusiastic and they run a bit too far ahead of gold and sometimes they do the opposite so they lag the price of gold.

A wonderful tool to examine these extremes is the Gold/HUI ratio chart… Over time (in a bull market) the Gold/HUI ratio drops since the gold shares do appreciate faster than gold itself. (Gold rose 180% since 2001 vs the HUI +1000%)

But as said before sometimes the gold shares are a bit too enthusiastic and run a bit too far ahead of gold which translates itself into a steep decline of the Gold/HUI ratio. What happens next is that the Gold/HUI ratio starts to climb for awhile until it catches up to its natural declining trend-line.. And exactly this is what happened since April 17, the Gold/HUI ratio appreciated from 1.61 to 1.91 thereby flirting with its 200 dma. From here on I don't see a much further upside potential for the Gold/HUI ratio so that simply means that the odds are in favor for a new down-leg towards new lows. Sure enough this will translate itself into new HUI highs

Please take peek at the chart below:

As this chart clearly demonstrates, all previous HUI up-legs of last year started on a high RSI reading of the Gold/HUI ratio just like we're seeing today (RSI stands at 65.19)

More importantly, the last time the Gold/HUI ratio chart such high RSI readings as we're witnessing now was in May 2005 and yes, that was a major bottom indeed and yes, the sentiment then was as bad as it is today. (see editorials Gold/HUI Divorce Part I and part II)

Furthermore we see that all HUI moves which started from a high RSI reading of the Gold/HUI ratio chart ended up with a gain of 50 - 100 pts…

So therefore I'm still confident to hold on to my previous target of 430 but it could be stretched out to well beyond that (480)


Eric Hommelberg
The Gold Discovery Letter/
The Gold Drivers Report

E-mail: ehommelberg@golddrivers.com
Web-site: www.golddrivers.com

May 14, 2006

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