Lassoing the Golden Bull: One Hell of a Bumpy Ride

| About: VanEck Vectors (GDX)
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Roland Watson (The New Era Investor) submits: Back in January, we had a go at estimating where the leading index of gold stocks, the HUI, may eventually end up in this first major gold bull of the 21st century. In that article, the estimate was made for an ultimate high around 1175 in 2012.

Based on a typical HUI leverage of 4, this implied that gold might well top out at $2100, though we would not hold to a gold price purely based on one conjecture.

The HUI was at 310 when that article was penned, whereupon it charged with nostrils bellowing to just over 400 before correcting back to the price when we penned the aforementioned article.

So, this would seem an opportune time to see where the HUI now grazes as the bull takes a temporary rest. First we look at the technical aspects followed by a summary of where the fundamentals lie.

The current leg up which has just completed is what we take to be Elliott wave 1 of wave 3, started in May 2005 at a price of 165. If 401 is the wave 1 top, a Fibonacci 38% retracement comes out at 311 which is six points above the 305 bottom which completed a day or two ago.

HUI (Gold BUGS INDX) 1-yr chart:

HUI # 1

However, a 50% retracement of this entire move takes us further down to 283, which happens to be where the 200-day moving average sits with a value of 280. This would suggest that a possible floor for this correction lies between the 38% and 50% retracements or 280-310 points.

Using the previous behavior of this bull market (see six-year chart below), we see that there were three major corrections of 46%, 65% and 42%. We can thus expect a similar pattern of behavior as this correction works itself out. Indeed, the current correction down from 401 to 305 comes out at 42%, so it finds itself in good company historically. However, we must caution that a repeat 65% correction is still an outside possibility!

In that previous article, we mused as to the possible target area for this current wave 3. Based on a 1.618 extension of wave 1 (which was 35 to 258), we came out with a run of 481 points. Since May 2005, wave 3 has already covered a mighty 236 points. Since our current correction has gone down to 305, it would take another 341 points for the HUI to reach our wave 3 target of 646 (165+481). It seems that this wave 3 still has some way to go.

HUI (Gold BUGS INDX) 6-yr chart:

HUI # 2

We may also comment on the velocity of this current move. In our previous article, we suggested that this current wave 3 could last 3 years. Since we believe wave 1 of 5 sub-waves in wave 3 has completed, that prediction still has some legs since wave 1 took exactly one year to complete and we still have four waves to go.

The other possibility from a purely structural point of view is that wave 3 may actually have completed well ahead of schedule. This would imply that wave 3 equals wave 1 for size but lasted 1 year as opposed to the 3 years for wave 1. This is possible though less likely simply because a comparison of other smaller waves in this bull market have wave 3 lasting at least as long as its preceding wave 1.

So, we note that possibility but for now it is a definite lesser interpretation and with the next leg of the dollar bear market about to accelerate, we are rather convinced of more mighty moves ahead of us.

In that light, the other remarkable feature is the sheer speed at which this wave is moving. The previous impulse wave took three years to cover 223 points (HUI 35 to 258). Using months as our time metric, we get a velocity of 6.2 points per month.

Incredibly, the current move of this year up to 401 clocked 19.7 points per month or over three times faster! Clearly, big money is beginning to move on these stocks and install turbo boosters on them but a rest is also required.

From a fundamental aspect, I was casting my eye over the main page of Yahoo! Finance recently and beheld someone urging an evacuation from commodities lest ye be consumed! These are the people who probably never saw this commodity bull coming, let alone got on board the shuttle.

It’s a pretty safe tactic to put down one bull market, so long as your readers are invested somewhere safe, earning 5%. They won’t make a killing but at least they are not losing big time either. The one truth I would acknowledge is that commodities are indeed more volatile markets, but if you want to make some money you’ve got to be prepared to lose some money.

If anyone is losing sleep over their precious metals investments, I suggest they put their mental health before their financial health and reduce their positions. I for one could not stomach being 100% invested in a sector so volatile. But one thing is for sure; I am invested to a reasonable degree that reflects the risk assessment of my capital.

Consider this: the US dollar bear market has resumed. The dollar index once again is hovering over its multi-decade support line of 80. This has never been meaningfully breached in over 30 years. It will be a major event if this line is broken and stays broken.

On that day and from hence forward, there will be pandemonium in the currency markets. It will be alien territory and a true signal that the US dollar’s days as the world reserve currency may be numbered. Now, that may not turn out to be the case, but you can be sure that multitudes of traders will be assuming this.

The battle lines are drawn, as commodity investors get nervous. Will this 30-year support line for the dollar hold?

Many are betting it will, simply because it has before. That’s why the gold, HUI and silver prices are getting jittery as we approach this dollar barrier. Volatility rules at historical boundaries.

Sure, there are negatives that may upset the gold apple cart in the not too distant future. For example, what if recession arrives in 2007? What if Chinese GDP growth falters? We know about these uncertainties.

But then there are the other factors in favor of gold. We mentioned the faltering dollar, but what about the continuing war on terror? What about inflation making a comeback or energy prices continuing to press on higher? Remember gold and oil moved in lockstep in the 1970s despite several recessions.

We say, commit your capital according to your comfort levels, sit back, and enjoy the ride. As you can plainly see, it will be one hell of a bumpy one!

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99.

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