ON YOUR MARKS, GET SET…
Troy Schwensen CPA
The following is an extract from the February 07 Issue of The Global Speculator sent to subscribers on the 2nd March 2007.
GOLD MARKET UPDATE
The last month has seen a breakout of the Gold price which was not supported by the Gold shares. This in the past has typically meant that any upside potential in the precious metals shares has been limited. As it happens, this has been confirmed again with a sharp pull back in both the Gold price and the Gold shares, perpetuated by a serious correction in the broader equity markets. In my opinion, this is just what we wanted to see and is a very healthy development in terms of the bigger picture. As I type this, the Gold shares continue to under perform the Gold price as it pulls back towards the neckline (US$650 - US$655) of a very bullish Reverse Head and Shoulder Formation. On measurement this pattern is signaling a potential intermediate term price target of US$740 an ounce or close to the previous high.
Over the next few days/weeks, I will be looking for the Gold price to decline towards the support of this neckline and for the Gold shares to start outperforming the Gold price in terms of the XAU/Gold ratio (See below for more detail). If this were to occur, I will be taking this as confirmation the intermediate term correction in the precious metals sector is complete.
XAU
XAU GOLD RATIO
As mentioned previously, we have continued to see the Gold price outperform the Gold shares this month with the Gold price putting on 1.7% and the gold shares retreating 1.7%. In a typical "sustainable" bull market rally in precious metals shares you would expect to see the shares outperform the physical metal by about 3 to 1 (See the above table). When the gold shares don't adhere to this norm, this at the very least should warrant caution.
I have received a couple of emails this month regarding the XAU/Gold ratio, with people intimating they may be hanging out for the 0.18-0.19 level to be hit before making acquisitions. At this point I want to re-iterate that there is no magic number as far as this indicator is concerned. For example, we like to do the bulk of our buying when the Accumulate Zone (Indicated in the above chart) is entered, as this usually coincides with value for money in many of the precious metals companies we follow. At this point in the game we are pretty much fully invested with the bulk of our buying taking place during June last year, with many of these positions considerably above what we paid.
The XAU/Gold ratio is essentially a risk reward indicator which generally moves in a range between 0.19 - 0.27 (During the bull market thus far). For example: To do the bulk of your buying at 0.25 based on the historical movements of this index intimates you are risking a downside of 0.06 for an upside of 0.02. In other words your downside risk is 3 times your upside potential which is not a good risk/reward scenario. We presently find ourselves at 0.21. The upside potential from here is now 0.06 and the likely downside potential 0.02. By hanging out for an absolute number like 0.18-0.19 (No guarantee of this level occurring) you are risking an upside movement of 0.06 in the hope of getting better value to the tune of 0.02 - 0.03. Like the first scenario the risk of holding out in my opinion is not worth the reward.
OUTLOOK
The two short term scenarios as I see it over the coming days and weeks:
Scenario 1: The gold price continues to sell off towards the US$650 mark with the Gold shares initially selling off before steadying and then rallying to the point where they start to outperform the Gold price. The XAU has support at around the 130 mark which may be tested in the process. In my opinion, a subsequent break of the resistance levels of 140 and then 150 will signal the beginning of a new "sustainable" rally in the precious metals sector. This is my preferred scenario.
Scenario 2: The precious metals market gets caught up in a broad commodity sell off and/or prolonged correction in the stock market, resulting in the XAU falling all the way down to either support at 115 or in a worse case scenario the long term support line at around 95. I see this scenario as unlikely at the present time.
Intermediate Term Outlook:
Over the intermediate term my next target for the XAU is around 180 (Close to the previous high) consistent with the measurement of the present Reverse Head and Shoulder pattern. This could then be followed by a more extensive rally that takes us to 230 over the latter half of 2007 or early 2008, depending on how long it takes this consolidation to run its course.
NORTH AMERICAN SILVER INDEX (NASI)
The Silver index broke out during the course of the month which coincided with it underperforming the physical metal (Middle section of the chart), signaling a pullback which has since happened. This has also meant the long term downward sloping trend line for the comparative relative strength with the silver price has failed to be breached. A break of this trend line is something that I think will eventually occur in the course of 2007 which will be very bullish in its implications.
OUTLOOK
The two short term scenarios as I see it over the coming days and weeks:
Scenario 1: With the present short term weakness in the sector, this could see a correction to support at 7,100 before the commencement of a sustainable rally which will see the resistance at 7,500 broken again and the relative strength comparative with the silver price breaking the long term downward sloping trend line. I support this scenario.
Scenario 2: If the Gold and Silver price were to get caught up in the sharp fall of the other commodity prices and/or a prolonged sell off in the Stock market, we could see a worse case scenario of a breakdown of the present consolidation pattern and a move of the index back to the long term support line at around 4,300. Whilst always a possibility, I don't support this scenario.
Intermediate Term Outlook:
Over the longer term my next target for the NASI is around the 11,000 mark towards the latter half of 2007 or early 2008, again depending on when the present consolidation ends.
CLOSING COMMENTS
Things are continuing to unfold very nicely in terms of this precious metals sector consolidation. In my opinion we needed this recent sell off to remove the last of the weak hands in preparedness for the next rally. Just to reiterate, the key indicator for me will continue to be the XAU/Gold ratio. Especially if we continue to see the Gold price fall further towards the US$650 mark. I will be watching the XAU and looking for evidence of it outperforming the physical metal. This will be a definitive signal for mine. The Gold price has already broken out. A pull back to test original resistance (US$650 - Now support) is quite normal and would be very healthy in the scheme of things (We may not even see it get that far). For anyone interested, I write a free monthly precious metals newsletter, which you can sign up for on the website below.
Troy Schwensen
The Global Speculator
March 2, 2007
DISCLAIMER
This publication has been prepared from a wide variety of sources which the editor to the best of his knowledge and belief considers accurate. The editor does not warrant the accuracy of the information and forecasts contained in this publication. This information is provided for educational purposes and nothing written should be construed as a solicitation to buy and sell securities.
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