Trading Price Objectives

March 16, 2004

This article is highly technical in nature and may be difficult for some readers to follow. For this reason, a summary of the article and its conclusions are set out by way of introduction:

  • Although a Dow Theory sell signal has recently been given by the markets, the Relative Strength charts are saying that the Dow is not yet ready to go into free fall
  • The "fear factor" that has been plaguing the markets is therefore likely to recede in the short term, causing commodities, oil and gold to pull back from their currently (long term) overbought situations
  • The primary reason that the Dow will not (yet) go into free fall seems to be that the Establishment still has some weapons in its arsenal. However, based on the low velocity of money, these weapons seem more likely to be related to political "jawboning" rather than being driven by Fed actions. Expect a steady stream of "feel good" news over the months ahead.
  • This feel good news is also likely to underpin a continuing (short term) rise in the US Dollar
  • Given that increased corporate profitability in the recent reporting periods has been significantly impacted by "apparently" improving streams of income from overseas (in reality more US Dollars for the same foreign currency earnings), a rising dollar is likely to have the opposite impact - ie it will place a cap on earnings growth. This is not likely to be well received by the markets
  • Insider selling has been extraordinarily high in recent months, indicating that managements can already see the writing on the wall, and cannot see a continuation of the currently rising trend in profitability
  • At some point in the next few weeks or months, when all the jawboning is behind us and deteriorating profits start to set in, the Dow Jones seems likely to go into free fall
  • At that point, the "fear factor" will probably begin to re-emerge, and gold, oil and commodities will continue their Primary Rising Trends. The US Dollar is likely to reverse back down as foreigners begin to pull their capital out, and Bond Yields will start to rise.
  • When the gold price finally breaks decisively above the $400/ounce level it seems likely to continue strongly upwards as it begins to become generally perceived as a safe haven. Because of the thinness of the gold market, the gold share market stock is likely to be difficult to acquire, and prices will start to rise strongly as a result.

Overall conclusion

The gold price seems capable of falling by at least 7.5% from this point, and the gold shares ($XAU) seems to have the potential to fall up to 26% from here within the context of a Primary Bull Market. The appropriate response appears to be to grit one's teeth and hang on to our gold investments. We are in for a rough ride, but will probably be better off holding on than selling now and repurchasing later because we may not be able to get back in.

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If you are trading oriented, gold looks overbought on the long term charts as can be seen from the PMO of the following DecisionPoint.com monthly chart.

According to the horizontal count method as applied to Point & Figure Charts, it could pull back to around $375/ounce, and the vertical count Price Objective is $364/ounce (fall of around 7.5% from current level.) (Charts courtesy StockCharts.com)

The following chart of the $XAU shows a possible Head and Shoulders reversal formation (cannot validate without volume patterns) which, if the neckline is broken on the downside, will give rise to a target move to around 72 ( a fall of 26% from current level)

The Point & Figure chart of the $XAU shows a horizontal count based downside target of around 84 - but only if the index breaks down through the neckline from here. I am inclined to view the 26% pullback as being more likely in the absence of any unexpected "driver".

So, the question is: Will Gold, and The Gold Index, break down from here?

Before attempting to address this question, it needs to be emphasised that none of these projected moves is expected to give rise to a change in Primary Trend. The gold price itself will need to fall below around $325/ounce for this to occur (see DecisionPoint.com chart below):

Further, the $XAU chart will need to fall below 69 for its long term uptrend line t penetrated on the downside.

The following chart shows that gold will have support from its 50 week Moving Average at around $375 - at which point the MACD histograms will probably be significantly oversold.

The 50 week Moving Average on the following chart shows support for the $XAU at around 90 and, more importantly, the MACD histograms appear already to have bottomed.

The issue that is concerning me more than anything else at present is that the Dow Jones looks like it wants to go seriously south - as evidenced by the fall in the % of shares trading above their 200 day Moving Averages (from 93% to 86% in the past couple of weeks)

If history is anything to go by, this ratio should fall to around 20% - 30% over the next 12 months.

The fact is that gold is NOT YET perceived by the mainstream markets as anything other than a commodity - as evidenced by the following ratio chart of Gold divided by the $CRB

This is not an opinion. It is a "hard fact". Gold has not been outperforming relative to commodities. It is therefore NOT, repeat NOT yet perceived by the market as the "currency of last resort"

If the Dow Jones falls, will commodities also fall?

The following is a relative strength chart of $CRB/$INDU. It shows that commodities have been pulling back relative to the Dow in the recent past BUT commodities are in a bull trend relative to the Dow.

The horizontal count measured move target on the chart below is 23 - which, if it materialises, will still leave commodities in a Primary Bull Trend relative to the Dow.

When we look at the behaviour of the $CRB by itself, the following manifests: The two charts below - when read together - indicate that Commodities are not yet significantly overbought from a long term perspective, but that the $CRB P&F chart may be heading for a "high pole" reversal in the short term.

The above is counter intuitive: How can the Commodities chart look strong if, at the same time, the Dow is weak and the Commodities look set to under perform the Dow in the short term?

This question is addressed by a different look at relative strength, as follows (Chart courtesy of BigCharts.Com): Since last April, the Dow has been rising at a significantly faster rate than the commodities index.

More importantly, on the shorter term weekly chart above, the stochastic of the $CRB is seriously overbought - thereby implying a short term mild consolidation.

But how can there be a short term pullback of BOTH the $CRB and the Dow Jones AND the $CRB still fall relative to the Dow (in terms of the Relative Strength P&F chart)?

The answer must be that the Dow is not (yet) going to go into free fall according to the above analysis, and that there is likely to be some continuing uncertainty regarding inflation/deflation. In short, "fear" seems likely to abate somewhat in the short term.

Against a backdrop where - in the short term - commodities look like they will fall around 10% relative to the Dow Industrials; and gold is in a short term bear trend relative to commodities, it looks like the pull back in gold shares could be up to 26% as being forecast by the Head and Shoulders formation on the gold chart (not yet validated)

This gives rise to the question: what is going to happen to commodities and gold in the longer term? Will they remain in their Primary Uptrends?

The short answer is: "Yes", and for the following reasons:

  • The commodities are only consolidating as a reaction within a Primary Uptrend relative to the Dow Jones. This Primary Uptrend looks likely to remain intact
  • The PMO on the weekly chart of the $CRB indicates that there is further upside in commodities, and the break-up through the 265 level was a significant development
  • The Gold Price appear to have significant support at the $325/ounce level - should it get there and, if it remains above $325, it's Primary Uptrend will remain intact.

One unresolved question revolves around the Dow Jones Industrial Average. In terms of Dow Theory, the Primary Bear Trend has resumed, and in terms of the chart showing % of stocks above their 200 day Moving Averages, the % seems likely to fall precipitously in the next twelve months or so. Why then is the Relative Strength chart of the Commodities vs the DJIA signalling a near term continuing pullback of commodities relative to the Dow - particularly given that the commodities are unlikely to fall precipitously?

This analyst's logic tells him that the Federal Reserve and the Establishment is going to throw everything but the kitchen sink at the equities markets in order to keep them from falling apart in the lead up to the Presidential Elections. I am expecting "everything" to include "media disinformation" that is calculated to "jawbone" the markets up. Such actions could include the following:

  • An announcement that Osama Bin Laden has been captured
  • An announcement that transition of power in Iraq has been successful, and we can look forward to a resumption of oil flow from that country in the near future.
  • An announcement that the existence of life on Mars has been verified, and that this validates the recently announced proposed ratcheting up of the Space Program which, in turn, is likely to have a stimulatory impact on the US economy given that HUGE capital sums will be invested - thereby lifting some of the weight of responsibility off the shoulders of the consumer.
  • A fall in the oil price following a back room short term "deal" being hammered out with the Saudis (From the oil chart below, it looks like $38/barrel might represent an interim peak) (Chart courtesy of http://tfc-charts.w2d.com/chart/CO/W )

The main reason I am expecting this jawboning is that Money Supply manipulation has been failing and Velocity of Money has been in a falling trend relative a rising trend of money supply.

HOWEVER, (and there is always a however), the hype associated with all this good news is likely to cause the US Dollar to continue rising in the short term, which, in turn, is going to place downward pressure on corporate profits (It has been the weak dollar that has contributed significantly to strongly rising corporate profits as overseas profits have "artificially" been inflated by an improving exchange rate - more dollars for the same number of Euros, as an example)

When the markets eventually start to focus on the negative impact of the rising dollar, (which insiders are already signalling THEY are expecting given the large volume of insider selling that has been taking place over recent months), the Dow Jones is likely to go into free fall.

At THAT point, cash will flow out of equities in earnest looking for a home.

Up to now, the cash has been flowing into Government Bonds (which is why the yields have been falling)

But when the equities markets start to fall in eranest, and the US Dollar resumes its downward trend soon thereafter (or perhaps simultaneously) the game seems likely to change.

At THAT point, foreigners will start to pull their money out of the USA and look for other places to park it.

Amongst other things - such as a fall in non US interest rates as foreign currencies strengthen - three significant developments seem likely to emerge:

  1. The dollar prices of Commodities, Oil and Gold will start to rise strongly once again
  2. Yields on US Government bonds will start to rise
  3. The property market seems likely to be badly hit

3. above is the main reason one should be keeping an eye on Fanny May's chart

Note that its MACD is seriously overbought, and that like the Dow Jones Index, its price has been rising on FALLING volume (Bear market action). Interestingly, the On Balance Volume is still in negative territory - notwithstanding its recently rising price.

Overall Conclusions

The game of market manipulation seems likely to continue for up to a few months (maybe only a few weeks) - with "jawboning" likely to replace purely economic actions of the authorities.

During this time, the US$ will continue to rise, and commodities, oil and gold will pull back from their overbought positions.

A point will be reached where the rising dollar will start to impact negatively on US corporate profits. At that point, the authorities will have nothing left in their arsenal to fight falling equities markets, and the Dow seems likely to enter free fall.

Timing is impossible to call with any degree of accuracy. Given this factor, and given the thinness of the Precious Metals markets and their related equities markets, it seems to be "too smart" to try to job in and out, notwithstanding the possible significant pull back of gold equities.

This analyst has decided to grit his teeth and hold on for a rough ride, in the conviction that the markets could "turn on a dime" and having concluded that the PM markets will remain in Primary Bull Trends.

As an aside, the "risk exposure" of the Comex Silver Traders who are net short the market grew from $2 billion to $2.6 billion in the six months to mid February ($100 million per month) and this risk exposure has grown a further $400 million (to $3 billion) in the past four weeks - indicating a rate of acceleration to $100 million a WEEK!

This situation cannot continue indefinitely, and something has to give. If the Silver market becomes dysfunctional in the near future, this might negate any attempts by the authorities to jawbone the markets up, and the fear factor could re-emerge very quickly. This is another reason to avoid trying to outsmart the markets. They are becoming too volatile to try to "trade".

China has only 2% of its Total Foreign Reserves in gold.