The HUI Gold Bugs index is at a technically critical stage the intermediate term. The action over the next 1 to 3 of weeks will likely provide a tip-off as to whether a full force resumption of the secular bull market in gold stocks is resuming, or whether gold stocks are now simply overbought and due for yet another painful correction. The long term basis for this determination is found within both Elliott Wave theory and simple logic. In tonight’s article, I describe the simple logic behind the long term evaluation of gold bugs index, and the short term indicators that are likely to shed light on the likely short, intermediate, and long term action in gold stocks.
Referring to the long term weekly chart above, the simple logic that is shared with Elliott Wave theory is that bull markets occur in three distinct “up” waves that are separated by “corrections” which move against the long term up trend. These three waves are separated by three distinct types of aggressive buyers. The first group that accounts for the first of the three up waves is the one most knowledgeable in the fundamentals behind the bull market. These intelligent folks and insiders are comprised of those who fundamentally understand the justification behind the new bull market. It is these individuals that are aggressively buying while the crowd is selling. In the case of gold stocks, this Wave I began in late 2000, and lasted until December of 2004. Bull markets never go straight up and therefore, there are corrections that follow each distinct long term up wave. The corrections re-instill the bearish sentiment in the crowd that existed before the beginning of the bull market, yet some if not most of the original gains made in Wave I, still stand up in the face of this correction. In the case of the HUI bull market, this long term correction began in December of 2004 and lasted until the spring of 2005, a period of almost 1-1/2 years. While the beginning of the bull market carried the Gold Bugs index from about 35 to almost 260, the correction that followed only took the index back to about 164, thereby preserving most of the initial gains. Less obvious in terms of simple logic is the breakdown structure of long term trends. Whereas long term bull markets occur in 3 distinct up waves with 2 corrective waves in between, each of the 3 distinct up waves also break down into smaller components of 3 up waves with 2 corrective waves in between. In the case of Wave I in the gold bugs index, these 5 sub-waves are indicated in blue. Similarly less obvious in simple logic is the breakdown of the 2 corrective waves, that tend to form in three sub-waves, labeled a, b, and c in green. (The corrective waves tend to be more difficult to characterize compared to the waves that follow the long term trend.) It is my belief that gold stocks are in a long term bull market, and that we have only completed Waves I and corrective Wave II of the 5 waves. Long term Wave III (up) is now in progress since early summer of 2005. Within the Wave III sub-structure, we have only completed Wave 1 (up), and since spring of 2006, the gold bugs’ index has been in a corrective (down) pattern (Wave 2) within Wave III. Returning to simple logic, after being thrown off by corrective Wave II, it is during Wave III that the largest and most powerful class of investors and speculators (“the crowd”) enters the bull market. It is at this point that the crowd’s sentiment becomes bullish, AND that the bullish sentiment shown by the crowd is also correct. According to Elliott Wave theory, third waves are often the longest and never the shortest of the 5 wave pattern. This is probably because of the power behind the most aggressive buying of the crowd. (And least aggressive selling.) A simple examination of the gold bugs index chart above clearly shows how difficult the Wave 2 corrective pattern has been for both gold stock bulls and bears alike, as the price action fluctuated between 350 and 275 for a duration of over a year. The critical question at hand is whether or not the gold bugs index is beginning Wave 3 within Wave III. The reason why this question is critical is because third waves tend to be the longest and most decisive of the 3 upward waves within 5-wave bull markets. Whereas in a corrective Wave 2, the most successful strategy is for traders to buy oversold markets and sell overbought markets, the opposite strategy (buy markets that are going up and hold on) would likely prove to be most successful in a Wave 3. So are we there yet? A closer look at the recent Wave 2 correction in the gold bugs index is in order. The corrective wave begins in April 2006, shown by the blue line. It is likely that the corrective Wave 2 pattern is defined by the down sloping blue trendline of lower highs. As can be seen, this trendline is being approached (touched, even); and if the trend is broken, this will likely signal the beginning of Wave 3. Note that since early October; the weekly action in the gold bugs index is consistent with a third wave. The trend has been up, while corrections against the uptrend have been short in duration and shallow in magnitude.
While a break above the blue trendline would strongly suggest the beginning of Wave 3, a failure near the trendline would suggest merely an overbought condition and more heartbreaking action in the gold bugs index in the weeks ahead. There may be additional insight that can be gleaned from some individual stocks comprising the gold bugs index, including the index leaders and laggards. First let’s look at a leader – Agnico Eagle Mines, Ltd. (AEM). It appears that AEM has broken out of its trading range whose upper range is at about 40. This could be a bullish tip off for the gold bugs index.
Wave 3 is when the crowd is correct. Newmont Mining Corp. (NEM) is an index-lagging stock that is followed by the crowd as indicated by its frequent mentions in Barron’s and other similar mainstream publications. Therefore, although this stock is a sector dog, its price action is likely to provide insight as to whether the gold bugs index will resume a strong and decisive Wave 3 of Wave III bull market. A break above recent weekly highs would be a likely tip off of the beginning of Wave 3. If NEM can retake former support (now resistance at 47.5), that would speak bullish volumes about the gold bugs index. After all, a rising tide lifts all boats.
Returning to simple logic, although it is a long way off, Wave V up is driven by overzealous speculators and those investors that are not considering fundamentals. Often times fifth waves occur as folks simply chase price action. In my view, in terms of gold stocks, this speculative fifth wave is a long way off. Today’s Market Tonight’s article was drafted last night (Wednesday 29 November). Today (Thursday), the action in both gold and gold stocks added evidence that the gold stocks have entered into Wave 3 of Wave III (!). This evidence is simply shown in the update of the chart of the corrective Wave 2 in the gold bugs index. Note the apparently broken down blue trendline.
Similarly, Agnico Eagle Mines, Ltd. (AEM) has put in a strong day, thereby putting more space between the current price and the former trading range:
If there is anything for the gold bears to hold on to, it is the action in Newmont Mining (NEM), which acted well today, but has not cleared former resistance (Yet).
What would disprove the theory that Wave 3 has begun? If AEM were to be pounded back into its former trading range with the other gold stocks acting poorly (and moving back into the year long downtrend), this would seriously frustrate gold stock bulls, and the selling could gain momentum. Given that it appears that the inflation strategy of the government, the Fed, and Wall Street seems to be total denial of inflation, there is a lot of “incentive” to hammer gold stocks back into their former trading range and frustrate the bulls. If they can do this, it will provide excellent cover for denying the presence of serious levels of inflation. If my goal was to deny inflation to the public, and I had enough funds, ethics aside, that is exactly what I would try to do to the gold market. But until these technicalities come to pass, there is every reason to remain short term bullish on gold and gold stocks. More evidence of monetary inflation is the outperformance of gold compared to commodities as measured by the CRB index as shown in the chart below:
This chart provides evidence that monetary inflation is the goal of those that control inflation, and they have been quite successful at that game since late 2005. I call this a decisively broken trendline. Notable in today’s market are the following: - Trading volume this week has been relatively high with little net price movement. This suggests that there is likely to be a turning point occurring soon. While there is still not adequate evidence to sell or go short, the market is probably near an important turning point. Everyone is expecting a “Santa Claus rally,” and professionals are expecting a bullish market with Wall Street bonuses at stake. Although they tend to be correct during Wave 3’s, at important turning points in the market, “the crowd” tends to be wrong. - Retail stocks are underperforming the overall US stock market. The 2 year chart of the Retail Holders ETF (RTH) versus the S&P 500 is anything but bullish.
- The homebuilders, despite apparently horrible near term fundamentals (except for interest rates), are rising in the manner that GM has risen a short time ago. It appears that the homebuilders are going to move back to the neckline of the completed head and shoulders pattern and this would set up the selling opportunity of a lifetime.
Have a great evening. Martin Goldberg
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