The Progression of the Golden Bull

March 27, 2002

First let me make the following disclaimers. Everyone must do his or her own due diligence. Nothing in this essay should be considered investment advice. I am long gold and silver in the mining shares, options on futures, as well as physical. I stand to make a considerable amount of profit from a rise in the price of gold and silver. I may change my perspectives and or take profit without having time to report said changes.

Two of my previous essays ("Riding the Golden Bull" & "Trading the Golden Bull") have described a heuristic justification for the gold bull and discussed trading in this market. In this essay, I will try to add a bit of technical analysis so as to help us see the "progression of the golden bull".

I made the following prognostication in March 9th of 2002.

[The XAU closed Friday (editors note: March 8 as shown by the red block arrow in the chart below) AT the bottom of the channel formed by the November and late December low (and the corresponding December and January highs). Monday is going to be an important day.

Thus, I disagree w/ Droke. We have not yet violated the XAU up trend channel. If this is the move in gold that many think it is, then we should bounce strongly on Monday.

Further, Friday closed a gap in the XAU from late January AND it created a gap between 61.96 and 62.34 ... filling this gap on Monday can only be considered bullish.

If we do not bounce on Monday, then I may have to concede to Droke's position …] PMtrader Mar 09, 2002

This post placed a burden on the reader to check the charts and try and picture what I was describing in words. This essay is an attempt to ease that burden for the reader. Further, while my work implied that Droke might be a bit pessimistic, I granted that his claims were at least reasonable. Suffice it to say that we had a strong bounce on the following Monday. The probabilistic event that a (admittedly subjective) channel analysis predicted was validated. The following Friday again confirmed this analysis.

There is a principle in science known as Occam's razor that says "everything being equal, the simplest explanation is probably the right one". There seems to be an analytical corollary for market analysis. When "channel analysis" (basically simple trend analysis) serves to explain and predict market behavior (in that it is very simplistic in nature), it seems consistent with Occam's razor to conclude that it is probably correct.

In this discussion, we will focus on the XAU. Zelotes (a.k.a. Adam Hamilton) and I discussed the pros and cons of this measure in Mining the XAU for Gold. Suffice it to say that a rising XAU speaks well for gold (granted that more leverage will be obtained with a portfolio of unhedged producers as I discussed in "Finding Leverage in the HUI".)

Consider the chart shown below. This chart is a candlestick daily chart of the XAU, which includes the November 2001 low all the way up to Friday's (March 22,2002) close. The first thing to notice is the green block arrows. Before the appearance of the red block arrow, the channel bottom was ambiguous. It was only after the appearance of this March 8th low, that the bottom of the channel was known with any degree of confidence. Note further, that the next Friday confirmed the bottom of the channel as shown by the uppermost gold arrow. With the benefit of this information, it is now clear that the gold (and red) arrows define the channel bottom and the green arrows were misleading. The bottom of the channel is shown as the bottom blue line labeled number 3. Now consider the blue lines labeled number 2 and number 1. I submit that the bottom channel (formed by line 2 and 3) represents a less excited market state (drawing a corollary from energy states in atomic theory) and that lines 1 and 2 form a second channel representing a more excited market state.

Now notice the green circles in the chart above. These circles surround areas where it is clear that there was a considerable amount of energy being spent by the market in order to determine the next direction (up or down). In particular, notice the green circle in the middle at the right of the chart (which contains a portion of line 2). This circle represents (to keep with our atomic analogy) a point in time where the market was attempting to drop to a lower energy state. The energy expended in this transition seems clearly to be more than any other of the green circle transitions. One might conclude that the gold market was loath to drop to the lower market state.

Now look at the gold circles.

The first one on the left may be equated to the idea of the market transitioning to a higher energy level. Look at how easily the market passed through this point. It is apparent that the market was returning to a more excited state with virtually no resistance! … like it was a natural state for the market! Now consider the gold circle at the right. This circle contains Friday's close. If the market passes through this area with no resistance as it did before, then it appears likely that we will soon test the upside of the channel associated with the higher market-excited state (Level 2).

In closing, consider the green line together with the bottom blue line (labeled 3). One might reasonably argue that these two lines define the channel and the idea of discrete market states introduced in this discussion are not confirmed. This is simply the subjective nature of channel analysis. The true test of any analysis technique is its ability to give you an edge in understanding the markets. As the ideas introduced in this discussion have helped me ride this golden bull, I thought they might be worth sharing.

Don't make any investment decisions based on the ramblings of this gold bull …

I am toying with the idea of spending more time analyzing the gold market. In order to do this, I would need interested readers to subscribe to an annual daily column for $50 to $75 (of your hard earned $s) per year. If any of you think the musings of this gold bull might be of interest in this format … drop me a line at the email below.

One cubic foot of gold weighs more than half a ton (1,306 pounds).