Weekly Gold Market Outlook
A Gold & Currency Digest
Time to Pull in the Horns? Maybe just a little...
A return to more normal commentary will coincide with the issue of our annual review and outlook this week.
I know that some clients are pondering whether they should sell this gold rally, seeing as it looks increasingly like the final buying climax that I've been describing and calling for since the summer of 2004. I have too. After all, in terms of extent and duration, the gold price sequence that began in 2001 now represents the metal's best overall advance in 25 years, signaling loudly a new bull market era; and at Monday's highs (US$565.50 on the February COMEX contract) it finally matched the upside momentum of the leg that occurred in the final inning of the 1987 "bear" market rally, which peaked in May of that year at a 34 percent year over year gain (gold 'prices' as opposed to momentum peaked seven months later, but only marginally higher than May's levels). Hence Monday's high returned one of my minimum milestones, and is only about 10 points beneath the low end of my intermediate target range (US$575-$633 for the current intermediate leg - that is the trend that started last summer)… so the answer for the money manager seeking to maximize his/her long term bull market returns is yes, it is probably time to start building cash reserves.
We're not picking tops here. Nor am I calling a reversal on this thing yet. I still think this move has legs. However, I don't know how much more those legs can take it - whether it is 20 or 200 points - before the next intermediate/primary correction sets in.
The further past my targets that the market goes the more likely the next correction will be a primary one, marking the end of the first phase of this bull market; the corollary of that proposition is that if a correction starts here (i.e. just below my target range) it's likely to be either a little backfill, or a normal intermediate correction (15-20 percent in gold prices and up to 30% in the gold stock averages), and not a primary (trend) liquidation of the sort that interrupted the 1970's bull market on more than one occasion.
So the recommendation to build cash reserves reflects my reduced certainty about the short-medium term, but also, it reflects an objective discipline - for the reason I use targets in the first place is precisely in order to take some of the subjectivity out of the decision making process at times when it is most likely to be influenced by emotional factors. Naturally, the main idea is to stay long for as much of a given bull market as possible. It is easy to get bucked off early, like the many bulls that turned bearish on the stock market as early as 1993/94 found out as it tripled and quadrupled later. It is not easy to ride the bull from start to finish, and then not to forget selling at the finish line. But it is made easier when the investor takes advantage of the extremes by selling "some" strength… because it frees up some capital for those unexpected but inevitable cracks, or other opportunities, and also allows some margin for error when it comes to future selling decisions - i.e. objectivity is easier if one isn't overextended.
It may be hard to pick the tops, but one can adopt a strategy to account for that fact.
Our preferred strategy is to wade into positions, and wade out… this was the moral of the Jesse Livermore story, if you ask me.
Thus, at most I would suggest selling no more than 10-15 percent of the overall gold and/or gold stock position. My short and intermediate term outlooks for both gold and the gold stocks have been downgraded to moderately bullish from very bullish (long term outlook remains "very" bullish) to signal the fact that we have come so close to the low end of my expected target range.
If you don't like cash, bolstering your bearish bet on stocks & bonds would be my second favorite call.
My third favorite call would be to do nothing at all but close your eyes for the next several years.
CURRENT PROGNOSIS
As you know, nothing goes straight up... or down for that matter.
The gold rally looks to be in good shape from where I sit, technically, and specifically as regards its potential to overshoot my near term targets. A 20 to 30 point pull back here first would be normal and healthy; signs of it may indeed have surfaced on Tuesday in the way of a minor reversal day (where, usually following a rally, the market makes a higher high but closes on its lows in a flurry of activity signaling the beginning of at least one round of profit taking), but it stopped short of an outside down day!
Another bearish fact was that this occurred following news of a flare up in tensions between the western nuke monopoly and its competition in Iran which continues to defy US/UK/Japanese calls to halt its nuclear weapons program, and which is normally the kind of noise that brings in the folks conditioned to buy gold on breaking crisis news… though I don't know whence they would have gotten their conditioning, since it hasn't been rewarding to do so for as long as I can remember trading this thing.
In any event, I can offer two general interpretations of these facts: 1) the market is overbought, at least in the short term, and/or 2) the bulls are still in control of the trend and are merely selling this news, which is normal (healthy) behavior - in this case "healthy" means that such rational action could extend the potential time frame and upside of the current intermediate leg.
But there were two other less general factors at work on Tuesday also, which could have explained the tone: 1) the DJIA looked as though it was turning over again, and 2) USd bulls successfully defended a key short term support point on the dollar index chart.
The currency is in technical no-man's land. The bulls failed to reverse the primary bear market sequence (2001-04) in November, and have since struggled to keep the 12 month uptrend from reversing - leaving them only Tuesday's rebuttal (in the USd index) to hang their hopes on; the bears, meanwhile, have to contend with the fact that the intermediate trend has not yet turned in their favor in any of the key currencies as well as the possibility that the bulls might be setting up for another run at the 92 handle.
Of course, the fundamentals for the greenback get more bearish every time the name Bernanke pops up on the screen... every time he's called an inflation fighter in fact. I suspect that his first task is going to be to dispel the notions growing in gold circles that he's anything but that, which is another reason to take "some" profits prior to month end - to expect otherwise, that is to expect that he will ignore those charges and carry on like nothing is changing, is to bet that his time preference rate is shorter term than Keynes's. Seriously though, I believe that his first few moves as chairman should be something to watch for.
The action in gold may be somewhat of a test for him because the metal, which everyone knows is somewhat of an inflation barometer, is extremely strong just as the Fed is contemplating an end to its rate hike campaign. What's he going to do?
Will he stop the rate hike campaign for fear of tipping the balance toward the DEFLATION bogeyman, or will he extend it in order to reassert his veil as an inflation fighter? The former would merely underpin price trends and threaten to upend the complacent balance in Treasuries which would only force him to consider the latter… failure to do so may prompt gold prices to drive higher.
Yet with stock prices still trading at over 15 times earnings, which growth itself is slowing because of the slowdown in monetary "stimulus" during 2005, an unexpected tightening action could indeed tip the balance… not towards deflation, but towards another (inflationary) recession, and rout in asset values. I doubt it's safe to depend on bond market support out of Asia these days.
But I guess the crucial factor is still that any additional rate hikes aren't as likely to stick at the short end, as in the long end.
This is because we believe the stock market is due to turn down, with or without any additional rate hikes.
The upshot is that a bounce in the US dollar and a decline in the DJIA could provide some short term resistance for gold, but that the bounce in the US dollar index does not have legs and the decline in the DJIA is fundamentally bullish for gold because it usually prompts a new round of monetary stimulus (liquidity), not deflation. My prognosis has always allowed for a knee-jerk pull back in gold prices on the initial evidence of a stock market reversal, but it should be followed by higher highs as the sell off in stocks continues, at least until a clear downtrend, or potential bottom, develops in stocks and bonds, detracting from gold.
I continue to favor this prognosis, and the scope for downside in stock prices is alone large enough to drive gold prices higher.
I'm not looking for an intermediate correction at the moment, but booking some profits can't hurt, in case I'm wrong this time. The next milestone is the US$600 range for gold, and the 325 handle for the HUI, where we might take another 10 percent off the table.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
January 18, 2006
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