first majestic silver

Brave New World

June 15, 2005

Below is a 20 year chart of the goldollar index - which is derived by plotting the product of the US Dollar Index and the US$ price of gold per ounce.

It will rise under two circumstances:

  1. If the gold price rises faster than the US Dollar falls
  2. If the US Dollar rises faster than the gold price falls

In either case, if the goldollar index is giving buy signals, it is signalling a change in the underlying "truism" that the gold price and the US Dollar move inversely to one another.

Up until now, this analyst has been focussing on the ascending Right Angled triangle formation that has been developing over the past few months, and which was resolved on the upside a few days ago as the index broke up through the horizontal resistance line.

The strong rise since the breakout a few days ago has caused me to look more closely at the weekly chart above (courtesy decisionpoint.com) and it appears that there is a possibility that the neckline of an inverse Head and Shoulders formation may also have been broken to the upside.

One problem with this type of formation is that it is so easy to see H&S formations that many rookie (and even experienced) analysts see them even if they are not present. What validates a H&S formation is the following:

  • It must occur at the culmination of a Primary or Secondary Move (up or down)
  • The volumes patterns of the H&S formation must corroborate the price movements.

It follows that an "apparent" H&S formation that manifests as a reaction within (as opposed to culmination of) a Primary or Secondary move is not valid; and neither is it valid if volume does not confirm.

Whilst 1 above is in this case potentially "true" we do not have volume available to us on this chart to provide validation.

Nevertheless, by way of satisfying our intellectual curiosity, let's pose the question "what if". What if this is really a Head and Shoulders Reversal formation?

The first factor that jumps out at us is that it has taken TEN YEARS to complete. This is certainly not trivial, and can be likened to the change in direction of travel of a passenger liner on the ocean. Once the change has been completed, it is unlikely to change back again for many years - if at all.

This being the case, if the recent upside move did indeed represent a breakout from the resistance neckline, the market is sending a clear signal that the inverse relationship between the US Dollar and the price of gold is H-I-S-T-O-R-Y.

The second implication of such a breakout would be that the "eventual" price destination estimate of around 5,000 is likely to be very reliable (without reference to the time it will take to get there).

Empirical observation of thousands of charts by the guys and gals who write books on this subject has led to the conclusion that the "measured move" target following a breakout from a neckline will be roughly the same distance FROM the neckline as the distance between the extremity of the Head TO the neckline. In this case, roughly 1,250 points from the 3,750 level.

At this point, if I was Mr Warren Buffet, I would be in "validation" mode. What the breakout is telling us is that either the gold price is going to rise strongly relative to a fairly stable dollar, or the dollar is going to rise strongly relative to a fairly stable gold price, or that they are both going to rise in tandem. You do not want to be short of the US Dollar under such circumstances.

Of course, this is just intellectual gymnastics - because the volume is not available to corroborate, and I am not sure how one would even plot the volume of a hybrid chart. Perhaps you would add the two volumes together? It hasn't been done before to my knowledge.

One can only speculate what such a breakout might mean, but one thing is certain: We are entering a Brave New World where the rules of the game are not yet defined. The comfort zone of many analysts - that has prevailed for decades (including, presumably, that of the analysts in the Think Tanks and the US Federal Reserve Board) - will have been left behind.

No one; repeat no one, can make any sensible forecast as to what this severance may mean based on historical empirical information.

In this analyst's view, we have no tools available to us - other than the charts - which will allow us to make any sensible observations. All we can turn to is the "Collective Unconscious" of the markets as a whole.

An analysis of the ultra long term chart of the gold price indicates that the price of gold could legitimately move to any level between $400 and $850 per ounce; and an analysis of the ultra long term chart of the US Dollar indicates that whilst the target move of the US dollar could be anything from 85 to 115, the only observations that can be made with a reasonable amount of confidence are as follows:

  • The US dollar will probably not fall below 80 in the foreseeable future, and
  • The Gold Price will probably not fall below $375 per ounce in the foreseeable future

So, you want me to take a "punt" on the levels at which both counters will stabilise?

Well, as long as it is clearly understood that this is nothing other than a punt based on "gut feel", the following are my best guesses:

  • US Dollar: will move between 90 and 100
  • Gold: will move between $400 and $500 an ounce

One of the elements of human nature that I find most appealing is that we have a wonderful capacity to adapt to circumstances. I am picturing a shrug of the collective shoulders of society, and a resigned acceptance that, whatever we are stuck with - well, we are stuck with it and we had better make the most of it.

So let's get on with the job of living.

Mr John Mauldin, I salute you. It looks like you were right all along. Maybe we are just going to muddle through all of this for many years to come.

And, if the markets are going to become a playing field fraught with nothing but frustration, perhaps we can once again look to the humanization of society - where people start to care more for each other than for their possessions.


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