Dr. Clive Roffey
The fallout from the sub-prime debacle appears to have cooled off. Decisive action by central bankers has shown their resolve to unblock the flow of inter bank lending. But has it left an indelible scar on the confidence of investors? Memories are short lived in the market. There is too much going on at any one time for a single news item to maintain front page dominance for longer than a week. I expect by the end of October nobody will be interested in sub-prime problems any more. However it remains to be seen what the fallout for the rating agencies that somehow managed to find a reason to classify a bundle of BBB rated bonds as AAA will be. I do not expect this potentially fraudulent action to disappear into the mists of time.
Irrespective of the reasons the gold price against all leading currencies has broken upside out of the triangular patterns with a typical surge. The full implication remains that gold has once again become the centre pivot of the currency system and there is a worldwide flight to protection. This is also intimated by the yield on the US 30 year T-Bill. Ben Benanke was forced to reduce interest rates by 50 points in the wake of the sub-prime fiasco. But the long term rate data is looking decidedly bullish for the US 30 year T-Bill rates. I am expecting to see long term rates rise. This at first sight appears to be an anomaly as short term rates are falling. But a rising long term rate implies that the face value of the bond is falling and this in turn indicates selling. For well over a decade long term US bonds have been the safe haven for global investors. My data implies that this is changing and that there is a slow but noticeable exodus from this long term safe haven.
The triangular pattern on the gold price has several implications. Whilst the triangle is forming it implies uncertain fundamentals. But once the breakout occurs it indicates that a new set of well definable fundamentals has occurred. I interpret the breakout by gold against all the leading global currencies from the 18 month triangle as indicating that there is a strong fundamental move to protection and hard assets. Couple this with the determination of all the central bankers to maintain economic growth plus the continued growth surge in the Far East and you have the basis for an explosion in commodity prices.
A broad based bull trend gives very few analytical problems. Some sectors move faster than others but most move in tandem in the same upward direction. This market is different. For the past three years I have continuously detailed that we have entered a resources dominant cycle. This is more pronounced than ever. At this stage of the market's development it is essential to realize that the most important technical tool is relative strength. Forget about all the oscillators and other wonderful tools. If the sector is not out performing the market norm then ignore it. Stick to those areas of the market that have performance and at this point of time it is all the base and precious metals, mining and resources sectors.
The gold sector has started to outperform all the global general equity indexes and I expect to see this continue. I expect to see gold outperform silver and platinum and for the sub performing gold stocks to move into a strong catch up trend.
The long term message is simple. Stay with resources with a significant gold portion.
I have above detailed the various segments of the triangle and its reaction in terms of fundamentals.
Triangles can be split into two stages. In the first stage marked in blue there is high volatility due to the fact that the fundamentals are uncertain and fluctuate quickly. The second red stage sees a marked cooling off in the gyrations of the share price and the fundamentals become boring. Comments from analysts during this period state that it is going nowhere and is likely to continue doing so. They discount any future action from this boring data. How wrong can they be! Once the triangle has approached its apex there is a sudden breakout as a totally new set of fundamentals becomes apparent. This new fundamental attitude becomes the driving force for the sustained growth of the stock and it catapults away into a new strong bull trend.
It is also interesting to note that the main trend going into the triangular pattern is usually repeated after the breakout and the triangle merely acts as a breather in a continuing long term trend.
This is the chart of Anglo American and during the build up of the second phase of the pattern in 2005 I was constantly detailing that a breakout from this boring, going nowhere picture was imminent. The same data was evident during this period on the chart of Impala Platinum and the JSE Resources index.
The gold price has an identical build up and breakout.
When we apply the same analytical approach to the gold price we note that the same first high volatility was evident in the blue area and that this was followed by the cooling off stage of boring fundamentals in the red stage. The strong price breakout from $680 to $740 indicates that a new set of fundamentals is driving the gold price.
Gold has been variously classified as "just another commodity" by a short sighted US politician. But is generally viewed as a "safe haven" in times of uncertainty. Some 35 years ago I coined the phrase that "gold is the barometer of instability". It is also viewed as the ultimate hedge against inflation as well as being a hedge against currency devaluation. But all of these labels effectively indicate that gold is acting as a protection asset.
In my analysis the breakout by gold from the triangle is a strong signal that there is a re-alignment of global investment attitudes towards protection rather than unbridled growth. I also believe that there is a discernable swing away from long term bonds as a protection haven into the hard asset arena.
Gold, has since 2000, out performed the general equity index of the Dow as detailed by this weekly chart. But for the past 18 months inside the red oval it has been in a corrective phase that is again breaking upside in favour of the gold price over general equities.
In order to see the breakout it is necessary to expand the area inside the red oval and this is done in the chart below.
Gold is shown relative to the Dow on a daily basis for the past 24 months. There has been a classic triangular pattern on both the gold price and the blue relative strength data. In both cases the upside breakout has occurred. I have already detailed that this implies a new set of fundamentals driving the gold price. But it also indicates a new set of fundamentals that dictate a preference for gold over general equities.
The 30 year T-Bill has been in a long term trend of falling interest rates since 1995. This indicates a strong buying pressure for the T-Bills as a security haven. But the trend is about to be broken and I am looking for a reversal to this interest rate downtrend. This implies that there is a re-assessment of the value of the long term T-Bill as an automatic haven of security.
At this stage a return to the Elliott configuration of the gold price is necessary. I have long maintained that the big dip in the JSE Gold index from 2002 to 2005 was the large I-II correction and that once this had ended the index would move into a large wave III. This occurred but the move ran into the recent 18 month correction that is the shorter term minor corrective wave 1-2 inside big wave III.
The FT Gold index is an amalgam of gold shares from all the producing countries and represents a cross section of their movements. There is a very strong horizontal support and resistance line. In 2005 the index broke above this level and then moved into te recent 18 month consolidation phase above the breakout. It is interesting to note that the lows of the consolidation stayed well above the support level. This is a strong indication that buyers were finding value at a higher price levels. The recent upside breakout from the consolidation pattern has very strong bull market connotations. Without doubt the lead story of the past two weeks has been the surge in the gold price as it broke upside out of the large triangular patterns that had confined it for the past 18 months. I have continuously detailed these triangular formations that have been in progress on the gold price in every leading global currency.
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Dr. Clive Roffey
30 September 2007
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