They say chart analysis is an art rather than a science. People tend to see what they want to see when analyzing chart patterns, but that's the same with any economic discipline. The entire discipline rests on the assumption that patterns from the past tend to repeat themselves in the future. Say what you want about that premise, but assuming it is true more than half the time, then it can increase the chances of spotting a trend change if you have the fundamental analysis correct.
The basic argument of the gold bulls is that an increasing dollar supply means higher gold prices, ultimately. Since it's not a smooth 1:1 correlation, technical analysis can help pinpoint trend changes within that framework. Spotting the trend change early on is like finding a genetic match. The more signals you can amass of a change in pattern by matching it with the past, the better your chances of identifying it correctly. To protect yourself from seeing phantoms in the charts, though, you have to be correct about the fundamental premise, which will protect you even if you are wrong about pinpointing the timing of the trend change.
In my previous article, I made the argument that gold spikes when price inflation gets out of hand. It did this in 1980 when price inflation hit a modern peak of 15%, which is why gold quintupled from 1978 to 1980. There were legitimate fears of hyperinflation. This time, though, interest rates cannot possibly be raised to 20% to stop it, as happened in 1980. So, assuming the fundamental argument of the gold bulls is correct and a rising dollar supply means rising price inflation means a rising gold price (and over the last century that is certainly the case), the question is did we just see a major trend change? What follows are three major signals that we have. The conclusion being that this stage of the gold bull market since 2001 could be the wildest yet.
Signal #1 - 2008 vs. 2016 Bottom
The last time a gold bear market bottomed, albeit a little bitty one by time, was March to October 2008. In that window, gold dropped 34% in 8 months. The climb out of that bear looked like this:
An initial 22.4% rally over the course of four weeks, followed by a cooling off period of 7 weeks where gold didn't do much of anything on net. From November 25, 2008 to January 15, 2009, gold lost 4%. Importantly, the rally was confirmed by gold stocks as measured by the HUI Gold Bugs Index, below. The HUI is followed closely by the Market Vectors Gold Miners ETF (NYSEARCA:GDX):
The initial spring out of the gate for gold stocks back then brought them 65% higher in those first 4 weeks, outperforming the metal itself by almost 3x. This was followed by more outperformance by gold stocks during the ensuing cooling off period. The HUI still outperformed gold, losing 2.5% versus gold's loss of 4% over the same time period. The fact that gold miners were outperforming gold both on the way up and on the way down was a good sign the bottom was in. Overall, in that time period, gold stocks outperformed the underlying metal by about 3x.
Fast forward to now, and we have the same pattern. Here's gold from January 19th when the HUI last bottomed, to March 18th, 2016.
We see the same initial rally, this time 17% in 3 weeks. This is followed by a cooling off period of 6 weeks, where gold declines 1% on net. This time again, the rally is being confirmed by gold stocks, this time with even more extreme outperformance both on the way up and the way down.
From January 19th to February 11th while gold was rallying 17%, the HUI also rallied 65%, outperforming the metal by almost 5x. During the ensuing cooling off period while gold fell 1%, the amazing thing is that the HUI actually rallied a further 11%. Overall, since bottoming, gold stocks have outperformed gold by a factor 5.2x, compared with the 2.9x of 2008.
Signal #2 A Pattern of Gold Stock Outperformance
The second confirmation is a pattern of gold stocks rising in the face of declining gold on the monthly charts, aside from the 2008 bottom. This happened several times during the gold bull market from 2001 to 2011, but only once during the gold bear, and it was towards the end of it (assuming it is now over).
During the gold bull market, gold stocks rose in the face of a monthly falling gold price five times. Those were November 2002, June 2003, February 2004, May 2005, and August 2006 (blue arrows on Chart 5 below). Each month's outperformance only spelled relatively minor gains, but added up they spelled major outperformance over the course of the bull market.
Contrast that with what's happened during the 2011-2016 gold bear market. Only twice has the HUI gained in the face of falling gold on a monthly basis since 2011 (see Chart 6 below). The last blue arrow of outperformance is what would be the gold bear market bottom on December 3, 2015 at $1,045.40 if the bottom is in. Gold stocks continued declining up to January 19th so there's flexibility with where you want to count the official potential bear market bottom.
Signal #3 Three Consecutive Monthly Gains
The third signal as it relates to gold stocks that we have reached gold bear market bottom has not been confirmed yet, but it's close. That would-be signal is three consecutive months of gains for the HUI. Returning to this chart of the HUI during the 2001-2011 bull, but this time focusing on the red arrows:
Chart 5 Redux
Each red arrow shows three consecutive months of gains or more. That happened 10 times during the bull market. How many times during the bear? Look back at Chart 6, and you'll see the answer is zero.
Keep in mind that there is nothing magical about this specific way of dividing the numbers, looking month to month as opposed to mid-month to mid-month or any other combination that may look different. The point is, for gold bears none of these charts will be convincing. For those who believe in the fundamental premise of being bullish, however, and are expecting a bottom, we are looking at new signs we have not seen since 2011. If March closes higher for gold stocks, the third confirmation will be in.
From there, we can go back to fundamentals and say with more confidence that if indeed price inflation is headed to 5% or higher, gold prices could quickly fly out of control. The technicals of the bear market appear to be over, and the money supply is still rocketing higher with no end in sight, for the first time breaking the $12.6 trillion mark last week, according to Fed statistics. Watch out.
Disclosure: I am/we are long GDX, GDXJ, SIL, PSLV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.