Believe it or not but gold and its shares could be poised for a powerful year end rally. Last week we notified our members that the gold-shares sell-off was way overdone which translated itself in a HUI reading as if gold were trading at $550! So yes, we argued that the time was right to start accumulating the gold shares as the saying goes "BUY Low, SELL High!"
Gold shares selling as if gold were trading at $550 is a huge anomoly indeed and as we stated in our Gold/HUI update "Bloodbath - part III" such extremes never persist for a long period of time so something has to give..Well, it seems the HUI has rocked bottom indeed and is on its way back to levels one could expect with gold prices of $660+..
In this piece we will examine the current drivers for gold and its shares which could surprise us to the upside by year end.
Dollar heading towards new record lows within 6 months from now
After the FED cut its discount rate to 5.75% from 6.25% on Friday August 17 the stock market, gold and its shares took off. However despite the initial relief rally the markets remained extremely volatile due to massive fears for a financial meltdown. Many will argue that the FED has to cut its FED Funds rate target as well in order to make some real impact but the FED has promised to act whenever circumstances dictate them to do so. It seems only a matter of time before the FED start cutting rates in order to prevent a recession or even worse a derivatives meltdown which could steer the US economy into a depression. The calls for lower rates are getting louder and louder:
Feldstein Warns of Recession, Makes Case for Rate Cut
Sept. 1 (Bloomberg) -- Harvard University economist Martin Feldstein said the U.S. housing-market recession threatens to sink the broader economy, and the Federal Reserve can cut interest rates without abandoning its goal of price stability.
"The economy could suffer a very serious downturn,'' Feldstein, president of the group that dates U.S. recessions, told a Fed conference in Jackson Hole, Wyoming. "A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome.''
END.
Now what could happen if the FED decides to slash interest rates in crisis times like these? On October 21, 1987 the DOW crashed by 22% and Greenspan's response was to slash the Fed Funds rate by an unprecedented 60 bp in order to prevent a 1929 style crash.
The result?
Sure enough the dollar tanked, gold and its shares took off. The gold shares appreciated by 50+% in just three weeks time while gold rose 10%.... The dollar declined by about 9% during the remainder of the year.
As said above many experts believe that Bernanke will have to cut the FED Funds rate anytime soon. In case that will happen the dollar will resume its downtrend at an accelerated pace and gold and its shares will take off!
Now let's take a peek at the dollar chart and see if the recent rally has run out of steam indeed:
What do we see here?
Well, the overall trend remains down and it seems that the latest counter-trend rally has run out of steam indeed. A resume of the dollar's decline is well underway targeting new record lows within three to six months according to a research note issued by Goldman Sachs:
Dollar May Fall to Record Low Within Six Months, Goldman Sachs Says
Aug. 24 (Bloomberg) -- The dollar may decline to a record low against the euro in the next six months because U.S. economic growth will slow, forcing the Federal Reserve to cut interest rates, according to Goldman Sachs Group Inc.
From the current level of $1.3568 per euro, the U.S. currency will weaken to $1.43 per euro in the next three to six months, Goldman Sachs said in a research note yesterday.
END.
So the dollar resuming it's down-trend translates itself into gold resuming its up-trend. This up-trend is further fueled by an astronomical increase in demand for gold emerging out of Asia and the Middle East.
Gold demand exploding in Asia and Middle East
Gold demand is exploding in Asia and the Middel East and the end is nowhere in sight. Gold demand from India could surpass the 1000t mark for the first time ever!
Saudi gold demand up 30%
AME Info August 20 - 2007. Demand for gold in Saudi Arabia rose 30% in Q2 with Umrah pilgrims and tourists helping to drive up sales, according to Arab News citing a World Gold Council report
END.
India's 07 gold demand seen jumping by 50 pct -WGC
MUMBAI (Reuters) Thu Aug 30, 2007 11:15PM IST - India's demand for gold in 2007 is likely to jump by 50 percent, from 2006, to record levels as lower prices lift buying interest, a senior official of the World Gold Council said on Thursday.
If realised, Indian gold demand would exceed 1,000 tonnes for the first time
END.
World gold demand on recovery path, to rise further
Reuters, 31 August 2007
LONDON - Global gold demand is set to pick up with the end of summer doldrums and the last quarter may see more buying than last year as prices have been less volatile, analysts and traders say.
"I suspect as we move towards the latter part of the year, the buying pressure will increase in line with the fact that we are heading towards the Christmas period, the Chinese New Year etc.," said Darren Heathcote of Investec Australia in Sydney.
Indian festivals boost demand
India, the world's top gold buyer consuming a third of world gold output, is expected to see strong buying in the festival season that picks up in September and peaks in November with Diwali -- the festival of lights.
"Demand for gold will be significant in markets like India, the Middle East and other Asian countries. In these countries, economic and capital markets growth have been very good and investors allocate a surplus of that to gold," said Gnanasekar Thiagarajan, director at India's Commtrendz Research Management.
END.
Now that the dollar is likely to come down coming months combined with an increased demand for physical gold, how do you think the 'smart' money is positioning itself? Well, it seems they are betting on a massive increase in the price of gold towards year end.
COMEX Gold option open interest indicates potential major upleg in gold
Adrian Douglas (www.marketforceanalysis.com) who predicted the mega up-move in gold to $720 in 2005 by noticing a very large build-up of call options in the HUI component shares published a stunning report last week in which he sees a similar build up in call options in the October and December COMEX gold contracts. Adrian says:
Adrian further comments:
"This is phenomenal. The open interest in play on the Call side is a staggering 12 million ozs. That is almost 25% of the worldwide annual mine output!"
"Just as in my prediction in 2005 I consider option players highly sophisticated speculators. Such large and widely spread positions are not contrarian indicators."
"I conclude that smart money is being placed for a massive rise in the gold price."
The entire report can be read at LeMetropoleCafe
END.
No matter how you slice it, the outlook for the yellow metal towards year end is bright! Now what about the gold shares? Will they catch up on gold? Or could they sink in sympathy with the stockmarket?
Sure enough the gold shares have been hit really hard lately and as pointed out in 'Bloodbath- part II' this was driven by fear and forced massive margin selling. One of our members wrote me the day after the HUI's bloodshed:
Eric,
What happened yesterday was way beyond fear. It was forced, no-choice-but-to-sell-because-of-margin selling. It happened to me in one of my accounts. I simply had to off-load about half my positions at the bids, which were lower and lower. I'm sure that is what happened to many yesterday
END.
We informed our readers (Gold/HUI Update Bloodbath - part III) that blatant sell-offs like these don't happen that often and do present an excellent opportuntity to buy some of your beloved gold shares. The thing is that ther gold shares are dirt cheap these days and as the saying goes': 'BUY low and SELL high'.
Now many people do fear that gold stocks will be burned to ashes in case of a severe stock market meltdown. I don't subscribe to that theory since gold shares are tied to the price of gold and not to the stock market. The gold stocks did well in the stock market sell-off from 2000 to 2003, the Nasdaq dropped from 5000 to 1000 pts at one time while the gold shares rose by more than 500%. Even during the great depression of the thirties gold stocks performed well. A classic example remains Homestake Mining which rose by more than 500% during that time...
This time is different?
Well, not according to John Hathaway of Tocqueville Asset Management. In his latest essay "A New Chapter For Gold" he writes:
John Hathaway, Tocqueville Asset management
August 29, 2007
The general meltdown in credit is the ideal macroeconomic scenario to launch gold into all time high territory. While those same conditions have been disruptive for gold and gold shares in the short term as investors sell whatever they can to meet margin calls, it is important to understand that this is a necessary passage to higher ground. Gold must shed the perception of recent years that it is just another "run of the mill" tangible asset and emerge as the premier way to escape financial havoc.
Shrinking credit is a bad omen for future economic activity. A soft economy or, more likely, a recession in an election year, is a recipe for gold well above $1000.
Should gold begin to trade in earnest above $700, gold mining shares should also revive and head towards new highs.
END.
The message to panicked gold share holders the is simple: Yes, volatility is at extremes these days, but that's all in the game, it's a typical characteristic of the gold market and yes there aren't that much investors out there who have the stomach to ride this game till the end. As the saying goes, if you can't stand the heat then stay out of the kitchen, but if you are a true believer in gold's historical role of a safe haven then these times do provide great opportunties. The forced margin selling has pushed the gold shares to extreme oversold levels indeed, levels only seen a few times during this entire gold bull market which started in 2001.
HUI extreme undervalued against gold
The fact that the HUI was trading recently at the same levels as when gold hit $550 should ring a bell, see chart below:
This chart show the extreme divergence between gold and its shares, the HUI was trading recently at same levels as whith gold $100 cheaper than today! Such extremes never persist for a long period of time so something has to give, or the gold price will come down or the gold shares will be catching up soon. Well, it seems the latter is already well underway since the HUI is trading 40 pts higher from its (intraday) low on August 16.
The next chart I want to show you is the is the relative HUI chart. The relative HUI chart has proven itslef as the the most reliable chart when it comes to spot MAJOR bottoms. What I mean is this, when the relative HUI chart flashes a 'BUY' signal it is a real BIG one! Over the past 5 years the relative HUI chart only flashed a major 'BUY' for 4 times, see chart below:
Relative HUI chart:
The r-HUI chart is gold divided by its own 200 dma.It has proven to be a reliable indicator in spotting major bottoms for the gold shares in the past 5 years.
In our dispatch of August 19 "Bloodbath - part III" I wrote:
The relative HUI never dropped below the 0.8 ever since the bull market in gold started in 2001. Now last week the relative HUI dropped briefly below 0.9 and clocked a low og 0.89. Now if the HUI would go down to such depressed levels as the previous 4 times the relative HUI dropped to 0.80 then we could see the HUI clocking levels around the 270 mark. Well, I don't think we will reach those levels since the HUI already came close in doing so during the August 16 session intraday. The HUI dropped all the way to 284 during that day before recovering and closed out that day at 300.
END.
Again it seems that the HUI did bottom indeed on August 16 and is recovering nicely from deeply oversold levels! Sure enough the HUI has to overcome its heavy resistance at 360 but once gold is headed towards the $700 mark the gold shares will be catching fire as well.
Highlights:
Now where to go from here?
Well, if you are a believer in gold's future then these are the time to increase your gold share positions since the gold shares are selling at fire sale prices due to the extreme bearish sentiment. In other words, downside risk is low. Higher gold prices the years ahead will lift the entire gold share sector but the most exciting rewards will come from junior mining companies making new discoveries.
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