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Gold Woes!

David Chapman
January 24, 2005

Since making lows near $255 in 2001 Gold has had an incredible run up of about 65% to date. By comparison the S&P 500 is actually down 9% in the same period. The unhedged gold miners as measured by the Gold Bugs Index (HUI) is up 327% more than outpacing not only the S&P 500 and therefore the broad stock market but also Gold itself. Yet to listen to many analysts over the past year or so you would think that Gold and Gold stocks are just bad words and the focus should be as it is rightly is on what they consider to be the real stock market. Of course they could make an argument because since January 1, 2004 Gold is up barely 2%; the HUI is down about 17% while the S&P 500 is up 6.8%.

We are constantly amazed that just because Gold and gold stocks have stalled out over the past year that suddenly we get all these experts saying things like we told you so, gold really is a barbarous relic and the gold bugs are just whacko's anyway. Let's try another set of numbers on for size. Since Gold was set freely trading when the world came off the Gold Standard (officially August 15, 1971), Gold has increased from $35 to today's $422 for an increase of 1106%. The Dow Jones Industrials has increased from 856 to 10,471 for an increase of 1123%. Not exactly what we would call an overwhelming lead for the stock market. Yet over $50 trillion of assets are in paper assets (stocks, bonds etc) and barely $2.5 trillion is in gold.

The Dow Jones/Gold ratio stood at 24.5:1 when the world came off the gold standard and today it stands at 24.8:1. In 1980 when Gold hit its highs over $800 the Dow/Gold ratio fell to 1:1. The ratio peaked at around 43:1 at the heights of the stock market bubble in the late 1990's. There are many gold analysts that believe that the ratio will trade again at 1:1 before this current bear market in stocks and bull market in gold is over. Even if we were only to reach a low of 2:1 (which was the lows in 1932) or even 3:1 it still suggests that Gold prices have more to go up and the stock market has more to fall. We are showing a chart of the Dow/Gold ratio. We appear to bouncing off of what appears as the top downtrend line of the bear channel and we are below the highs seen through 2003/2004.

From 1982 to 2000 the stock market was in a major bull market rising from the depths of August 1982 at DJI 770 to the peak in January 2000 at 11,908 for a gain of 1446% over about 18 years. Meanwhile Gold topped out in January 1980 at $875 and bottomed out in August 1999 at $252 for a loss of 71%. Gold was in a major bear market. Of course in the 1970's it was the reverse as Gold gained about 2500% while the DJI was going nowhere. There are bear cycles and there are bull cycles. It is foolish to think that just because the Stock market has been in an 18 year bull market that the bull market would continue for ever. And similarly just because Gold had been in a 20 year bear market doesn't mean that it continues forever. Since the stock market peaked in 2000 the roles have reversed even though over the past year gold has struggled while the stock market has enjoyed some gains.

Just as there are cycles in the stock market there are also cycles in the Gold market. One of the best cycle analysts for Gold that we read is Ray Merriman of MMA Cycles. Mr. Merriman has identified what he believes is a series of 8.5 year cycle lows in Gold. It is difficult to say how dominate this cycle because we only have roughly 35 years of freely trading Gold. Our monthly chart of Gold shows that there have been 4 observations of this 8.5 year cycle with lows seen in 1976, 1985, 1993 and the 1999/2001 double bottom. The next one is due somewhere in 2009-2010.

If there is a 4.25 year cycle (half the 8.5 year cycle) it is sometime in 2005 and even into 2006. Is it possible we are in the process of making it now? We don't know for sure. Merriman also postulates that there is an 18.5 month cycle of lows as well. It is quite possible that low was made in May 2004. On a bigger scale Merriman believes that the cycle of gold lows has a bigger 24 year cycle and it is made up of three 8.5 year cycles. If that is the case 2001 would have ended that 24 year cycle and we are in the process of new long cycle. Since this would be first leg up of a new 8.5 year cycle it should or could be the strongest as was the case witnessed in the 1970's. That tells us that we could go as late as 2008/2009 before we top out in this cycle. We can't tell just yet where the top will be but if the Dow/Gold ratio were say 2:1 at the bottom then we could see 5000 DJI and $2500 Gold.

Intriguing is the gold cycle of the 1970's. In that cycle Gold started at $35 in 1971 and peaked in late 1974 at around $190. Gold then went into a year and half slump falling all the way back to just above $100 in August 1976. It was from that point that it started on its sharp rise to $850 in January 1980. The biggest part of the rise was in 1979. In the current cycle we bottomed in 2001 and we have had a peak at in late 2004 at $465. If we are still trying to make the 4.25 year cycle low it is possible that we could remain weak on the precious metals for the next year or so. The long term bull trend line is currently coming in around $340 and rising so if we broke through $400/$410 then a collapse to those levels is possible.

Not surprisingly the US Dollar that had collapsed from 1971 to 1974 corrected through 1975 and 1976 in an irregular up and down fashion. After the correction was over the US Dollar finished its collapse into 1979/1980. The US Dollar Index recently fell into a major zone of support from about 78/80 with the lows seen from 1992 to 1995 and bounced. So it is possible to have a corrective US$ over the next year or so to correct the 33% collapse from the highs in 2001. Rising interest rates are contributing to strength in the US$. Irrespective of the possibility of a corrective US$ over the next year longer term targets remain down to 60 on the US$ Index.

If this scenario were to unfold gold would remain weak throughout the period and of course gold stocks would remain weak. Still major support for Gold remains at $400/$410 and we admit we would not want to see that zone broken or the trend would definitely change to the downside. But there is also a bullish case that suggests that we may just continue the upward trend.

First Gold itself came out of a large bowl pattern with the 1999/2001 double bottom. Second we rose to the levels of the 1996 highs and then formed what appears to be the handle of a cup and handle formation. This formation projects up to $480 to $550. We did not achieve this in the last run up so those targets remain valid. Gold also broke above its 1996 highs at $410. The next major zone of resistance is the 1983 and 1987 highs between $500 and $510.

As well the Gold Bugs Index (HUI) (and the Philadelphia Gold and Silver Index (XAU)) may be forming a reverse head and shoulders bottom. We are showing the weekly charts of Gold and the HUI to highlight these possible patterns. The HUI possible head & shoulders neckline is around 245 and projects up to 339 as a minimum. Remember that at this stage it is just a potential H&S pattern and needs to break out on volume to confirm. There is still some more work to complete the right shoulder. It is important at this stage that we hold 190 to maintain the validity of this potential pattern. We would also want to see Gold take out $446 to confirm a new up move.

Cycles do turn positive over the next few months (starting around the end of this month) so it will be important to see if the rise is a weak feeble one or we do break out to higher levels and signal that the current gold woes are over.

David Chapman
January 21, 2005
Email:
david@davidchapman.com

Note: Charts created using Omega TradeStation or SuperCharts. Chart data supplied by Dial Data.

David Chapman is a director of the Millennium Bullion Fund.

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.
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