first majestic silver

Time to Get Serious

July 17, 2004

The charts of the gold price and the gold share indices are showing signs of life, and it is important that we get to the bottom of what this might be implying.

The above chart (courtesy Sharpcharts.com) shows that the $HUI broke up out of a downtrend, and is currently consolidating. The 228 upside price objective is the same using both vertical and horizontal count techniques.

The somewhat more conservative $XAU is yet to break up out of its downtrend, but there are technical reasons to believe that it will.

What are these technical reasons?

The daily bar chart below is reflecting a chart pattern sometimes referred to as an Ascending Right Angled Triangle. This is typically a bullish pattern which results in an upside breakout.

It can be better viewed (and the implications can be better understood) from the following weekly chart.

It can be seen from this chart that the MACD line has just given a buy signal, and that the MACD histograms have also entered positive territory.

There are two resistance levels that need to be penetrated on the upside before the bull market can seriously re-establish itself:

  • The 50 week moving average needs to be penetrated on the upside
  • The downward sloping trendline dating back to December 2003 needs to be penetrated on the upside

In my view, we are perhaps one to four weeks away from such an upside breakout. A resolution point is approaching in that the price is heading into the apex of an intersection of the intermediate term downtrend line and the intermediate term downtrend line already referred to above.

A very similar situation can be seen on the $HUI weekly.

  • There is an ascending right angled triangle (more clearly defined)
  • The MACD is about to give a buy signal

Paradoxically, the $HUI appears less bullish than the $XAU - given that the intermediate term uptrend line was previously penetrated on the downside. Why the paradox? Because P&F charts above show exactly the opposite situation, viz that the $HUI has entered a new uptrend and the $XAU has not.

What has the gold price itself been doing?

Aha! Here we have an even more interesting scenario:

  • The price is already above its 50 week MA
  • The MACD buy signal is occurring at a higher level (less bullish for the immediate future)

What has been happening over the past few months is that the speculative air has been escaping from the gold balloon and shares have come back further than the gold price itself. However, with the gold price itself now clearly travelling above its 50wk MA, the odds are that the shares are going to start catching up again.

What does the P&F chart of gold show?

Bingo!

The downtrend line has now been penetrated on the upside, and the uptrend line has now re-established itself.

Importantly, I am not yet looking for a Dramatic move up in either the gold bullion price or the gold share indices. In my mind, this will only start to become a probability (as opposed to a possibility) when signs of infrastructural decay start to set in.

What do I mean by infrastructural decay?

For one, the US dollar will need to turn bearish and fall below its previous low.

Secondly, I would expect that if this happens, the bond yields will start to rise again in order to protect the US Dollar.

Importantly, even though bond yields have appeared to be falling recently they have only been falling within the context of a rising trend - as can be seen from the above P&F chart.

The horizontal count is calling for a yield objective of around 5.8% whilst the vertical count method is calling for 7.2%.

Rising yields (to protect a falling dollar) are likely to cause some significant anxiety from several fronts:

  • Bond prices will be falling under such circumstances and Significant wealth will be lost.
  • Stock prices will likely fall (around half of the S&P companies are interest rate sensitive).
  • Property prices will come under pressure.

If this scenario starts to manifest, a panic could ensue and so we need to form a view of the likelihood of yields starting to rise once more.

There is also an issue relating to the parallel historical behaviour of share prices and gold share prices. For a "new" scenario to emerge - a serious Bull Market in gold - gold shares will need to rise even as equity prices are falling. This will represent a departure from historical experience and will represent the commencement of a new game.

OK, so where do we start?

First, there is the conundrum of falling yields and a falling dollar - which is what has been manifesting of late. Logic would dictate that yields should rise in the face of a falling dollar and this has not happened.

Note also from the above chart that the MACD is showing declining lows and the 50 day MA is perilously close to crossing the 200 day MA.

If a sell signal in the dollar is given it defies the odds that yields can continue to fall from here.

Well, the chart below seems to be giving contrary pointers to this argument. It is showing falling yields.

Except for one nuance: The 50 day MA is far above its 200 day MA.

In my view, the bond yield "could" continue to fall to as low as 5% before it hits serious support, and this will probably preclude the 50 day MA from crossing over. In addition, the RSI line is approaching oversold territory. So (if I am right) what we are witnessing is a "consolidation" of yields within a rising trend.

OK, let's look at the weekly chart:

The falling MACD confirms that yields could continue to drift - and the chart shows that yields could fall to as low as 5%, but here there are TWO support systems:

  • The 5% level is highly congested - indicating that further falls beyond 5% are highly unlikely
  • The yield will hit a rising trendline and possibly (probably) bounce up

What does all this mean for the equities market?

Well, I have come to understand over the years that if it looks like a duck, and it walks like a duck and it quacks like a duck, then it is probably a duck. In my view, the evidence is overwhelming that we have been witnessing an upward reaction within a Primary Bear Trend.

What do we have that is pointing to the probability that we are coming to the end of an upward reaction in the Primary Bear Market - as opposed to entering a new bull market?

  • In 1929 the ratio of Price to Book value was 4.3X it is now 5X (Fair value is around 1.7 - 2 X)
  • The S&P P/E Ratio is now trading at 21.39X (source Decisionpoint.com), vs "fair value" of around 15X

On a valuation basis, the markets are in cloud cuckoo land, and have been for some years. Ie The (only) reason share prices are where they are is "weight of money". There has been too much cash sloshing around, and not enough avenues for investments, and so "dumb" investment decisions have been the inevitable result.

But if weight of money is all that's holding up the markets then a RISE in interest rates will be a "kiss of death" to the equity markets (and the bond markets)

So, it follows that the absolutely critical factor that needs to be managed by the Fed is "interest rates" These CANNOT be allowed to rise under any circumstances, come hell or high water.

But, (and this point is so important that I am repeating the P&F chart below from a different perspective showing a 2.5% logarithmic reversal scale as opposed to a 2% reversal) the following chart is saying "up yours"

"The Market" is saying that yields are in a RISING TREND and it is telling the Fed that it can go to hell in a hand basket.

Overall Conclusion

The "Indian Summer" to which I referred some months ago is slowly and inexorably drawing to a close. We might have a few more months of "shenanigans" from the Fed as it ducks and dives and weaves and bobs to stop yields from rising.

Whilst that is happening, the gold and bond markets will consolidate sideways to up, and the equity markets will consolidate sideways.

However, eventually (probably approaching the elections) the yields seem likely to re-establish their rising trend, and once this happens there is very likely to be a panic leading to significant market falls and possibly even a serious crash.

At that point, the Precious Metals markets are likely to explode upwards, and we might even experience market dislocations as gaps on the bar charts start to occur with increasing frequency and magnitude.

Post Script

There is one chart that I have been following for many months now, and I have not seen other commentators refer to this chart in the way I have been viewing it. It is the MONTHLY chart of the Dow Jones as shown below (courtesy Bigcharts.com)

This particular chart has been scaring the bejeebers out of me because it is a LONG TERM chart, and long term trends cannot be "manipulated" by outside forces (not even the Fed)

In mid 2003, the price of the $INDU bottomed on high volume - indicating a market bottom.

However, what has emerged in the ensuing two years is classic bear market behaviour: Prices have been rising even as volume has been falling.

Note also how the On-Balance-Volume chart showed a double top in around January 2004. What this indicates to me is that the "smart money" has quietly (and slowly) been exiting the market in the past six months (note how prices have come back)

Yes, it could be argued that the OBV chart has been exhibiting much stronger behaviour than the prices in that the OBV line has been hovering around the same levels since 2000 - even as prices have fallen.

However, the "double top" in the OBV chart, when read together with rising prices and falling volume, when read together with the falling MACD histograms, are all pointing me to the conclusion that there is VERY unhealthy substructure to this market and that a market crash is certainly possible if not probable.

Finally, I would like to draw your attention to the monthly chart of yields going back to 1995

This chart is showing a CLEAR "diamond reversal" pattern dating back to mid 2002. Three months ago, this diamond pattern was completed as the yields broke to the upside. Since then, in accordance with classic technical theory following a breakout, the yields have been consolidating downwards. Also in terms of classic technical theory, the upward trend should soon start to reassert itself.

I also draw the reader's attention to the "spikiness" of the Rate of Change (ROC) histograms over the past few months - since mid 2003. This represents a departure from the previous "wave" patterns dating back to 1996 and ( in my mind at least) is indicative of external manipulation.

Note, however, that although the blue MACD line appears to be turning down, it is approaching the horizontal line which, if penetrated on the upside will indicate that the "fat lady has sung".

In my view, there may be a few more months of jawboning and statistical manipulation, and then the Indian Summer will (finally) give way to Winter.

What do we do about it?

Watch this space.


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