Today's Market WrapUp  04.19.2007  Mon  Tue  Wed  Thu  Fri  Goldberg Archive

Gold Stocks Ready to Surge?
Not All Signals Positive, Next Week Critical
BY MARTIN GOLDBERG, CMT

Gold, precious metals, and precious metals stocks are in a long term bull market and it appears that the Elliott Wave count is clear, readable, and legitimate. Also, the HUI Gold Bugs index is at a technically critical stage in 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 Elliott Wave theory. Yet shorter term, as the HUI appears that it might break into new high ground, not all signs point to an immediate surge. If the HUI breaks decisively above 370, that would signal the resumption of the bull market and it would even make sense to buy an overbought market. This would be the direct opposite of what worked since the beginning of 2006 which was to buy weakness and sell strength.

Referring to the long term weekly chart above, 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.

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.

Note: The foregoing discussion was a reprint of an article posted in November of 2006, but an updated long term chart is posted above. The discussion of the long term wave structure of the HUI is as legitimate now as it was then. The question at that time was whether the HUI was ready to break into Wave 3 of Wave III. In hindsight, the answer was “no.” And now once again, the HUI is in a similar technical position having tested both sides of the previous trading range. It now sits at a point where it might be ready to break into powerful Wave 3. But unlike previous tries of breaking decisively above 370, this time the HUI has both the 10 week and 40 week moving averages “in gear” and positively positioned. The shorter term average is above the longer term one and they are both sloped upward. But as the HUI sits primed to “break out” the HUI is also highly overbought and at risk of yet another correction.

Not every signal in the HUI has been positive. Among those less-than-bullish signs are:

1. Gold stocks are tracking all stocks.

2. A lack of full participation among all gold stocks.

Below is a year-to-date chart of the HUI with an overlay of the S&P mid cap ETF. It doesn’t take an experienced technical analyst to see that they are producing the same price action at the same time. This is too much of a coincidence to believe anything but the forces between the price actions amongst the two are exactly the same. As a long term gold stock bull (and a long term stock bear), it is particularly disturbing that the steep and short correction treated both asset classes exactly the same. This is especially true at a time when the uptrend in stocks is running out of power as indicated by diminishing “up” volume and mixed signals in the important Nasdaq stocks.

If the HUI were to break into new high ground simultaneously with a decoupling in price action with US stocks, that would be more bullish since it would suggest that the breakout was not the result of some nebulous liquidity phenomenon affecting all tradable assets. It would suggest a fundamentally driven rally.

Also disturbing is the action of household name, Newmont Mining, because one would expect that one of the largest and most liquid gold stocks is lagging all major indices including the HUI. Yet Newmont has reclaimed its (downward sloping) 10 week average. It would be encouraging if the HUI broke the 370 barrier while Newmont broke above its 40 week moving average. It is in a technical position where this could happen in a few trading days.

Similarly, a break of the downtrend in the liquid and dynamic Gold Corp. (GG) would provide some legitimate evidence that Wave 3 up has begun in the HUI.

Today’s Market

Precious metals and precious metals stocks took a significant hit today, especially silver which was down over $0.30 cents. Below is the long term weekly chart of silver. Since early 2006 silver has climbed slowly only to be hammered by a sharp painful correction. In spite of this, each of these sharp painful corrections has terminated in a higher low before climbing once again. Now with silver off by over 30 cents today, it would be logical to think that the same thing was happening once again. If silver produces behavior that is more bullish than what we have been conditioned to see for over a year, then this would be a strong indicator of the start of Wave 3. But until (and if) that happens, Wave 2 grinds on.

As has been the case over the last few years, bearish news has been met with bullish action. With the Shanghai Composite down over 4.5% overnight in the US, one would have thought that the major indices in the US would have been down. (They were in early trading.) But by the close, the US indices were up or near even. Especially bullish were semi-conductors that were featured in last week’s wrap up. All is not bullish, as there is still that troubling price/volume divergence that was referenced two weeks ago.

And speaking of the Shanghai Composite, here is the 2 year chart. Now going back 2 years, Asian growth was no secret that time, so it makes one wonder whether what is going on with the price action in the Shanghai Composite is something other than rational thinking about the fundamental value of corporations within the index. In light of the action that occurred in world wide markets during the short sharp correction in February, it makes one really think. How sustainable is the uptrend we’re looking at below?

Finally, if I was Warren Buffett, a value investor in a market where there is very little value, I’d think about buying stocks in a somewhat illiquid index such as in transportation stocks, and then put a lot of buzz into the press about what I was doing. When the stocks went up based on the much-ballyhooed Buffett “investment” I’d sell. I’d do the same thing if I were Kirk Kerkorian too. Why not make money on a sure thing? If it’s the type of market that supports such (herd) thinking, then why wouldn’t a capitalist do the capitalist thing in a market that supports such behavior? It’s only logical.

Martin Goldberg

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Martin F. Goldberg, CMT
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