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Sunday, January 31, 2010

The Prechter Gold "Buy" Signal Has Been Triggered

The recent decline in Gold has not only caused mayhem in goldbug-land (especially those holding mining stocks), but also brought deflationists of all stripes – with, not surprisingly, Prechterites at the forefront - out of the woodwork shouting $400 Gold from the rooftops. Funny, all I remember is a deafening silence at $1200. Emboldened by the recent decline, Mr. Prechter has predicted a 40% decline in Gold prices from here. For those not in the know, Bob Prechter has been forecasting declining prices for Gold all throughout its decade long bull run. For example, in March of 2006 when Gold was about $560 he said, "Gold is in the final stages of a speculative surge…technical factors, in conjunction with a complete wave pattern and sentiment, point directly to a decline to at least $460 and probably close to $400". It reached $730 in May and closed that year at around $650. In 2003 Alf Field – who beat Prechter at his own game forecasting Gold prices much more accurately than him using the Elliot Wave Principle – wrote, "In mid 1999, when the gold price dipped towards a low of $253, Bob Prechter forecast an extended rally in the gold price that would be followed by a final decline to below $253 to a low point approaching $200…he forecast (at the start of the move) that the peak would be about $360 and he recommended short sales in gold after the price moved above this level in February 2003. He now believes that the market is on its way down to new lows below $253". Gold closed that year at around $430. What would have happened if you took his advice and shorted Gold at $360? You would have gotten reamed, that’s what. Ironically, for all his blathering about "sentiment" and being "contrarian", Mr. Prechter has become a great contrary indicator for the Gold market. His long term stock market forecasting isn’t that great either (yeah, I know he’s made 4-5 correct predictions in the last 40 years), but we’ll leave that aside for now.

For those with a long-term horizon, the picture hasn’t changed at all and should keep buying the dips no matter what. But buy physical only and in your personal possession. I cannot stress this point enough. Even if you are a short term investor and like to trade/speculate you should keep a stash of physical not-for-sale and keep adding to it regularly. Think of it as taking profits in Gold instead of Federal Reserve Notes a.k.a. dollars. Now, for those of us inclined to speculate on the POG (Price of Gold), let’s take a look at the evidence and try to figure out where we are and where things are headed in the short term.

Is the Present Upleg Over?

Gold has had two major uplegs since its bull market began in 2001. Both have occurred during the seasonally strong period of September – May timeframe. Both occurred after long periods of consolidation lasting more than an year. The first one took us from about $450 to $730 – a gain of 62% and the second one took us from $700 to $1030, a gain of about 47%. The 50 DMA was barely breached in both of those uplegs. This present upleg has occurred in the same timeframe, but has given a rise of only 22.6% so far. It has also breached the 50DMA as well as the 100 DMA, although the latter has been breached only by a blip so it may be a false breakdown. In the past breaching of the 50 and the 100 DMA has signaled the sure end of the upleg but this time I suspect it may be different. “Why?”, you may ask. Well, first of all the rise has been piddly compared with the huge preceding 18 month consolidation. In fact, it’s barely visible in the log chart, when in fact the fundamentals have never been better for the Gold price, especially with Central Banks becoming net buyers instead of sellers for the first time. Secondly, I think too many people were looking at the past uplegs just like we are and were expecting the 50 DMA to hold, which is probably why it didn’t. Thirdly, the $1000 level was a huge resistance level, so the price retesting it should not be much of a surprise. Fourth, the US government has a record amount of debt to sell this year, which is why – as also speculated on ZH recently – it appears that they have green lighted a (what they hope will be) a managed selloff in all risk assets so as to hold down interest rates. They are playing the "Bonds-Stocks yo-yo" again, or at least they think they are. What they are forgetting is that Gold is increasingly becoming a wild card. Instead of going to either bonds or stocks, capital may flow into Gold – the real money - thus causing the "yo-yo" to collapse and trashing Treasuries, the dollar and stocks – all at the same time. Also, too many people are expecting a repeat of 2008 where everything went down including Gold and the dollar/Treasuries rose which is also a strike against the same exact scenario happening again.

Gold Daily Chart:

The bull run envisaged in the last update materialzed, but is far from over in my humble opinion. As evident from the chart $1075 which was resistance previously has become support now, as happened with the $1025 level. Gold appears to have put in a double bottom at $1075, if it holds i.e. Option expiration shenanigans definitely have a lot to do with many of these unexpected “corrections”. From what I have observed while trading futures, I gather that there are some pretty huge buyers/buyer at that level. When the price reached $1075 during Friday’s trading, the buy orders just kept coming and coming. Also, my sources indicate that there is heavy physical buying interest in Asia at these price levels and premiums have surged.

RSI and MACD are pretty much at the same levels they were when the price hit $1075 back in December, so no bearish divergences there albeit the Slow STO is exhibiting a small positive divergence. The Golden cross mentioned in the last update remains intact, a plus for higher prices.
The COT Situation:
This Friday’s Gold futures COT Report is definitely positive. Commercials covered a lot of shorts. They reduced their short positions by 22,734 contracts in futures for a net short position of 248,618 contracts. The last time we saw a lower net short position than this was at the beginning of September when it was 216,708 contracts, and has declined by almost 20% from a high of 308,231 when the price was $1226. The current net short position might likely even be lower since this data is as of Tuesday and the price has fallen even lower since then. Apparently, the bullion banks…er…”commercials” know something we don’t.

Also, small speculator net long positions reduced – always a plus since they tend to reach their lowest levels at bottoms - by a substantial 15,484 contracts from 52,178 to 36,694, a level last reached at the beginning of September when it was a net long of 32,207 contracts. This represents a decline of 31% from the peak. Interestingly, the small speculator net long positions reached a peak not at the high of $1226 (49,167 contracts), but at the January high of $1160 (53,146 contracts).
The US Dollar Situation:
The US Dollar has mounted an impressive rally, and if we look at the weekly chart the technicals definitely look positive with a rising RSI and MACD along with price (as they do on the daily chart). It has breached the 200 DMA resistance level accompanied by increasing volume in the US Dollar index bullish fund UUP. The 78-80 is also a significant long term support/resistance level, so until the dollar convincingly breaks past 80, we should look at it for what it is – a countertrend rally in a bear market. All the major moving averages are sloping down which is definitely a negative.

While the dollar could easily go either way from here, contrary to popular wisdom, even if the dollar rises, it does not automatically mean that Gold will fall as we witnessed at the beginning of ’09 when they both rose together. It was not a one-off event either. It has happened previously at the end of 2005 when Gold broke out of the $450 level. To be fair though, the decade long relationship between the US Dollar and Gold is definitely inverse. In my opinion, the issue is not as cut and dried as “Dollar up, Gold down” as the deflationists would have you believe. The dollar index can be a pretty misleading indicator as it can go up both on account of world capital flooding into the dollar as a “safe-haven” trade as well as other countries debasing their currencies faster than the US. In the latter case everything (i.e. stocks, commodities, Gold, etc.) can keep going up right along with the dollar as I believe was the case in 2005. Moreover Gold and the dollar are not the only assets competing for capital. We have stocks and commodities as well – the so called risk assets. In 2009 we saw Dollar going down, risk assets going up whereas Gold remained essentially flat. If and only if the dollar and Gold are the only two assets competing for capital we can say “Dollar up, Gold down”. To add to the confusion, most people tend to lump Gold with risk assets and when they say “Dollar up, Gold down” what they really mean is “Dollar up, risk assets down”. What they don’t realize is that Gold is in a separate class by itself. In fact, Gold is what people think the dollar is today i.e. money. The dollar is just a poser - a mass delusion, if you will. As more and more people wake up to this reality we can expect old correlations breaking down accompanied by increasing volatility as is happening now.

Capital today is trying to find a safe haven as we move along this deflationary depression. Initially of course some capital is expected to flow the dollar’s way since it has been the world reserve currency for so long (thus causing a rise in the dollar index), but as more and more people realize the sorry fundamentals behind the dollar and discover Gold as the true safe haven, Gold’s rise will in no way be impeded by the dollar. In fact, at some point, I expect even commodities to outperform the dollar (but still underperform Gold) as the illusion of dollar being “money” breaks down.
Gold:SPX Ratio
The bullish divergence highlighted in the last update played out (although not to the extent expected) and after rising from September through November to reach a high of about 1.10 it fell to around 0.95 in December. It has started rising again signifying that Gold is set to outperform the stock market once more. RSI and MACD are rising again and supportive of such a move. As we progress through the Gold bull this ratio will be in an uptrend. The 1.0 area which was resistance previously has turned into support. The ratio broke out of 1.0 at the beginning of 2009 and after an year long consolidation/retest and looks set to resume the uptrend.
The Gold-Stocks (Non)Correlation
Now after watching Gold rise along with stocks through the better part of 2009, many people believe that it will crash along with it as happened in 2008. What most people forget is that Gold completely decoupled from stocks from November 2008 till April 2009, at one point even moving inverse to it. What happens is that there are two sets of people buying Gold – strong hands and weak hands. Weak hands just play momentum and buy whatever is going up. They don’t really know much about Gold’s fundamentals and sell at the slightest sign of trouble. All the correlation junkies ala “Gold goes down when the dollar [index] goes up” also fall in this group. Thus during the initial downdraft in stocks weak hands panic and sell outnumbering buyers therefore causing the price to fall. As price reaches bargain levels, strong hands who are aware of Gold’s fundamentals i.e. know exactly what Gold is and why they are buying it, step up to buy whatever weak hands are selling putting a floor under the price. In fact we saw signs of such a floor (and Gold decoupling from stocks again) on Friday as the stock market got pummeled while Gold held its ground at $1075, even moving up towards the close of the session due to heavy buying at those levels. Now while it may not have bottomed out yet, this indicates that we are not very far away from one.
Gold has its own fundamentals driving the price having nothing to do with the stock market. In fact, I believe that Gold will see some of its greatest gains when stocks are being pummeled. People will see Gold holding its own amidst crashing stocks (and other paper assets, even commodities) and panic into Gold and out of stocks as happened in February ’09 when stocks were crashing and Gold was rocketing. The price will not really rocket (no, what we saw in November ’09 wasn’t it) until the bullion bank shorts ala JP Morgan get crushed and in their fear the herd might just run over them. Never underestimate the power of fear.
Gold:Oil and Gold:CCI Ratio

Although Gold has not really outperformed crude since February’09 and the ratio has remained in a tight, albeit historically normal, range of 13-16, it has started to rise again. MACD is rising and supportive of such a move. Although the ratio did rise to above 16 in Dec’09, I believe that the bullish divergence between price and MACD referred to in the last update has yet to play out fully. Another spike up is definitely in our future. Let’s also take a look at the Gold:CCI ratio which compares Gold to other commodities in general. After spiking from Sep’08-Feb’09 it has been consolidating till date and looks ready to spike up again. MACD and RSI are rising steeply now, after having remained in a sustained uptrend through the long period of consolidation thus supporting such a move.

Since this is a deflationary depression in terms of Gold (and NOT the dollar) and we should look for Gold to not only significantly outperform crude and stocks but other commodities in general and hence both of these ratios to be in an uptrend. In fact, if you zoom out on these ratio charts, you’ll see that MACD has been in an uptrend all throughout the “Hope ’09” rally. Also, the spike up and ensuing consolidation looks suspiciously like a bull flag. What this tells us is that Gold has been quietly consolidating against all the “Hope” and “Recovery” assets such as stocks and commodities ready to rocket up again. The spike to $1226 in November was just a small taste of things to come. In fact, I think that the coming spike in Gold will be a sight to behold and will surprise even the most hardcore gold bugs.
Long term the strategy remains buy the dips as Gold is in a bull market which is far from over. Short term we can expect volatility but $1000 should hold, although we are seeing increasing signs that we just might be at the bottom (including sentiment in the PM community which appears to be terrible right now – at least from the comments I’m seeing on various blogs) and just doing a second retest of the last breakout at $1075. If you are not leveraging, buy at will. If you are, make sure you have enough margin to hold your position even if price dips to $950-$900 just to be on the safe side since the bullion bank gold manipulators are adept at performing "bucket shop drives", as the famous Jesse Livermore called them.

The $1000 area - where we are right now - is a great risk reward point for those who are leveraging as you are only risking a possible $100-$180 move against you compared with almost unlimited upside potential. From being a massive resistance zone, it has turned into an equally massive support zone now that the price has broken out. Consider it a gift from your government.

Mr.Prechter wants you to choose this:
Over this:

What's it gonna be?


Disclaimer: Long Gold. What did you expect?