Home   Links   Editorials

Speculative bubbles

Jack Chan
May 16, 2005


Most of us who are active in the financial markets now were probably not around during the 1929 stock market crash, therefore, this article will not go there. But most of us remember the recent stock market meltdown in 2000. And now five years later, bulls are still bullish as ever, even when many portfolios are down in the double digits. What does it have to do with the gold market?


Yes, bubble.

A stock market bubble is created when speculation has gone excessive. But what is excessive? Have we learned anything from the Nasdaq bubble? Personally I have. I was heavily into tech stocks during the late stage of the tech bubble, and profits were good. I overstayed my welcome, by buying all the dips in 2000 and early 2001, and gave some of that profit back. Then I discovered gold. Its been heck of a ride, until late 2003. I do not know if the gold market has met the same fate as the dotcoms did, but with the lessons I learned from the tech bubble still fresh in my mind, buying and holding is the last thing I would recommend to my subscribers. I have stepped on some toes in my last two articles, suggesting those who recommended accumulating gold stocks were buying on faith, because my charts were not screaming buy. No offense folks, I only say what I see, as I do not believe in forecasting and market predictions. Markets are dynamic and subject to constant change, and that is the advantage of being a technician, because any major changes within the markets are quickly demonstrated by price action, and that alone is the best indicator in the business.

The tech bubble

Lets go back a few years. The Nasdaq mania gained 320% in 36 months from April 97 to March 2000. In hindsight, we now recognize that was a bubble. Also, notice that the biggest gain occurred during the last seven months, when Naz doubled from Aug 99 to Mar 2000.

The gold bubble

$HUI gained an incredible 600% in 36 months from Nov 2000 to Nov 2003, almost twice the Nasdaq mania in the same length of time! Again, similar to the blow off stage of the Naz, $HUI gained 120% during the last seven months from April 03 to Nov 03. Was that a bubble? You be the judge. But gold bulls' argument is that the $HUI is comprised of mostly junior unhedged stocks, therefore a lot more speculative than the big caps which comprise the $XAU. Alright....

$XAU - sure, only went up 166% in the same period, about 28% of $HUI's monstrous gain. But a bubble is a bubble, once its burst, its over.

If we look at the Dow during the same period of the Nasdaq mania, it gained only 83%, about 26% of Nasdaq's gain, very much in line with the differential between $HUI and $XAU. The fact is, big caps almost always underperform in a bull market and almost always outperform in a bear market.

The corrections

So, after the mania is over, what sort of correction can we expect? Lets look at the Nasdaq again.

Nasdaq lost 77% in 31 months.

While the Dow only lost 33%.

So far, $HUI has lost 30%, using the Nasdaq correction as a guide, it is quite possible we are only half way thru the correction in term of price and time.

$XAU, down 25% so far, should begin to outperform $HUI if the correction continues. Why? Unlike the $HUI and $XAU, the bullion is only down 5% from its peak, therefore, only two things can happen:

#1 - bullion continues up, eventually pulling gold stocks up with it thus ending the 18 month correction in $HUI and $XAU.

#2 - bullion goes down, corrects 50% or more of the entire advance, to the $350 area, taking both the $HUI and $XAU down in the process. However, because the $XAU is comprised of big caps who are notorious hedgers, the correction in bullion will not affect the big caps as much as the juniors.


I'm not suggesting that the $HUI must correct like the Nasdaq, but the fact is the 600% gain was excessive speculation anyway you look at it, and an appropriate correction is only normal.

Remember, analysis is nothing more than an educated guess. Price action is number one and we must be vigilant of supply and demand as clearly indicated by the best technical indicator in the business: price itself. A good trading model made up of a few simple technical parameters should guide us in and out of the markets safely. I will have no hesitation in issuing a buy signal when my homemade BPGOLD turns up. Analysis as this merely provides the big picture which shows the market as is, and it is up to us to accept that fact and execute our signals accordingly. Do not buy and hope just because many think that gold can only go higher. Be defensive and you will not have to suffer two crashes within a decade which is highly likely at this point. Some may argue that gold stocks are in a correction, not a crash. Call it whatever you want, the fact remains that $HUI has now lost 35%, that is the same as if the Dow was at 6500; headlines all over the world would be screaming crash, unfortunately gold stock investors are suffering in silence.


May 13, 2005
Jack Chan
email: jack@simplyprofits.org
website: www.simplyprofits.org

321gold Inc