Gold/Hui - Bottom Must Be Near!

May 12, 2008

In my piece 'The Investment Case for Junior Mining Companies' I suggested a bottom for the juniors must be near based on the CDNX/GOLD ratio. Furthermore I suggested that the next up-leg in juniors could be expected when gold bottoms out and starts a new up-leg again.

In this short technical piece I want to show a few charts which do suggest a bottom for gold (and major gold stocks) must be near indeed. The recent drop in gold has spooked many investors out of their gold positions but again investors should realize that we've been there before and nasty corrections like these will happen again and again during the remainder of this gold bull market.

Now let's start off with the 3 year gold chart. It visualizes the similarity of the major correction in May/June 2006 and current one:

This chart shows us the severe over-sold condition in which gold found itself recently. It was its deepest over-sold condition since June 2006! Since extreme over-sold conditions never persist for a long period of time a bounce back could be expected which is just what gold is trying to accomplish now.

That's the long term view, let's zoom in now to the last few months and see what the technicals are telling us:

This chart tells us that gold found solid support at the $850 level indeed and breached its recent down-trend (A-line) to the up-side. Although encouraging one should note that gold has to breach its other down-trend line (B-line) as well to the up-side in order to mark a new BUY.

The HUI is showing off a similar picture as gold so let's take a peek first at the 3 year HUI chart:

This chart is showing us an extreme over-sold HUI indeed which has bounced off lately from that over-sold condition.

These charts do look encouraging indeed but how can we be sure a major bottom has been reached by now?

Well, sure enough no-one can predict the future but one of my favorite charts does tell me that if we didn't bottom out now further downside risk seems to be limited to less than 10%!

The chart below shows you the relative HUI chart which has nailed all major bottoms since the beginning of this bull market in 2001.

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 7 years.

This relative HUI chart briefly touched its green BUY zone recently and bounced off immediately. This could mark the bottom for the HUI indeed although a brief return to the green BUY zone can't be ruled out either. The bottom line however is that down-side risk seems to be very limited here. Furthermore it should be noted that the relative HUI chart never found itself in the green BUY zone for more than a month. In other words, if we didn't bottom out now it won't take long before we do bottom.

Also when we take a peek at the short term it seems we've found another bottom for the HUI. At least that's what the GOLD/HUI ratio chart is telling us. Over the last two years the GOLD/HUI ratio chart nailed all the short-term bottoms for the HUI and has done so again last week:

As you can see the GOLD/HUI ratio reached an extreme again last week which normally points to a short term bottom for the gold shares.

What does it mean when the GOLD/HUI ratio hits an extreme?

It simply means that the gold shares are tremendously undervalued against gold. It happens all the time, sometimes the gold shares are too optimistic and they run ahead of gold and sometimes they are lagging gold tremendously. This becomes clearly visible when you plot GOLD vs HUI into one single chart, see below:

Clearly visible here is the irrational behavior of the gold shares in 2003 when they run ahead too far from gold. Right now we're dealing with a lagging HUI against gold as has happened two times more last year. The previous two times marked an excellent BUY opportunity for the HUI

So the charts are pointing here to a short-term bottom (GOLD/HUI ratio) as well towards a long-term bottom (relative HUI chart). The setup certainly looks good.

NOTE of caution:

No matter how good the HUI charts look like, all depend of course on the price of gold coming weeks. We already saw the gold charts on top of this page showing off the similarities between May/June 2006 and now but what does the relative gold chart say? Did it flash a major BUY yet?

The r-GOLD 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 7 years.

The relative gold chart did not end up in the green BUY zone. Now should we wait until it does? In order to do so gold should fall below its own 200 dma which suggests gold prices in the low 800's. I know there are quite a few gold analysts out there predicting such gold prices indeed but in order to do so gold should break its strong support level at $850 to the down-side. For me as an investor it doesn't bother me. Again, the only thing that matters is that down-side risk has dropped below 10%! Just think about it: when looking back in 2012 with gold prices at $2000 and more would you regret it buying gold at $880 in 2008 instead of maybe $820? No, of course not, as the saying goes " BUY low, SELL high" it's now the time the add to your existing positions. The risk here is to be out of the market, not to be in.

A one-ounce gold nugget is rarer than a five-carat diamond.

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