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Gold - Rising Again!

David Chapman
Jun 1, 2004

It has been a rough five months for gold bugs. Gold topped in early January, then double topped on April 1 near $430. Stocks, as measured by all the major indices XAU, HUI and the TSX Gold Index all topped in early December with lower and/or double tops coinciding with the gold tops in January and April. The failure in April then triggered a sharp sell off into the recent May lows where the indices fell about 32% from the highs. Gold fell from $430 to $372, recording only a 13% loss. Silver was hit harder falling some 32% in less than two months. To put that in context though silver almost doubled from lows in 2002 so this could be viewed as an overdue normal 1/3 correction.

Since the lows made on May 10 Gold has climbed over $20 and the indices are up over 20%. We suspect that the weakness seen over the past few months has been gold making its 18.5 month low. The major low in gold was made near $250/$255 in both August 1999 and April 2001 a period roughly 19 months apart. There is evidence over the years of the gold contract (since 1974) of lows roughly 18.5 months apart with an orb of 15 to 22 months (Ray Merriman on Market Cycles).

The next 18.5 month low was made in July 2002 (15 months) targeting the period November 2003 to June 2004 for the next 18.5 month low. The market did not top until January so this right skewed cycle is telling us that the market is quite bullish. Since the lows in 1999/2001 the market has made a series of higher highs and higher lows telling us that we have embarked on a new bull market. Merriman also believes that the lows in 1999/2001 was the 8.5 year cycle low as well targeting the next major 8.5 year cycle low in 2009/2010.

If the markets remain bullish, as we suspect, then the 8.5 year cycle will not crest until late in the decade. If the market is making its 8.5 year cycle crest now then we will fail the recent highs at $430 on this up move. Breaking under $330 would tell us that the 8.5 year cycle has crested. But given the huge bowl pattern on gold made from 1999-2001 the cycle has probably not crested and we should target over $500 in the next leg up with a minimum target of $488 once we take out $430.

So what is once again driving gold higher? As usual the US$ is playing a key role. The US$ had been enjoying a rally largely on the back of the possibility of a higher interest rates and higher yields in the bond market. A lot of carry trades are being unwound especially those invested in foreign currencies (a carry trade is where you borrow for short terms in low costing funds - US$ and invest the proceeds in higher yielding instruments either in the US but usually more profitably in foreign currencies).

But the US$ Index has run into stiff resistance at the 40 week moving average near the recent highs at 92.62. A break of 89 on the index would send the US$ lower and be positive for gold. New highs could target up to 94/96 and even up to long term resistance near 100. That scenario remains possible at this time but a firm break under 87 would probably negate that scenario and instead target new lows.

A better reason for gold's recent rebound may be seen in the reappointment of Alan Greenspan for another 4 year term as Fed Chairman. Setting aside that it is an unprecedented 5th term and that Mr. Greenspan is 78 years old it is a testament to the man who wanted to be Fed Chairman during the Kondratieff winter because he believed he could beat it. His method of course is to keep interest rates low (artificially below the rate of inflation) and maintain liquidity in the market.

Since the beginning of the year money supply growth has been on a tear. M3 is increasing at a 10% annual rate and has added $262 billion in the first four months of the year. This is interesting given that in late 2003 M3 had been weak and actually fell on a few occasions. Loan growth particularly consumer credit and mortgage has also continued to grow and of course there is no let up in the triple trillion dollar deficits of budget, trade and current account. The recent trade numbers were a record deficit fuelled heavily by record high oil prices.

The figure of $262 billion M3 growth in the first four months of 2004 is almost as much as all of 2003. That allowing this kind of growth accompanied by comparable debt growth is irresponsible seems moot. It is doing the job of maintaining economic growth (artificially) and holding up the stock market at overvalued levels. To the extent that some recent economic numbers show some weakness it will allow the Fed to continue or even increase the recent sharp growth in money and hold off on interest rate hikes. But the question that should be asked of those who are buying and holding the broader markets is to quote a screen legend "Do I feel lucky".
There are reports that Mr. Greenspan has paid quadruple the number of visits to the White House then he did under Clinton and that the Bush administration left the reappointment of Mr. Greenspan until the last minute awaiting solid evidence that he would do the right thing to help ensure the re-election of Bush jr. It would appear that the White House has thus far been right in its faith. Gold then should be alarmed. The recent rally in gold coincided with the reappointment of Greenspan demonstrating at least that some do not share the same faith.

The commercials Commitment of Traders report (COT) was 17% in mid April. The most recent numbers indicate that has climbed to 38% bullish indicating that the commercials were covering heavily as the market fell into its May lows. As well short positions in the major gold stocks also fell as the market moved lower indicating that they were covering shorts there as well. If gold is still being manipulated as some indicate then the commercials have rebuilt their arsenal and may be prepared to once again to sell the market as it moves higher. The question of course then becomes can events (such as a terrorist attack) overwhelm the shorts that will certainly build as we move higher again?

Gold stocks, while up, are not as yet setting things on fire. So there appears to be some disbelief that this is for real. At some point then there could be a test of the recent lows. If that comes we suspect it could come in July but in the interim stocks have an opportunity to return to near the highs seen in December/January. The early stages of a new bull in golds usually see the large/intermediate producers lead the way. These are the stocks to own in the early stages before moving progressively to the junior producers then finally to the junior exploration plays in the latter stages of a new 18.5 month cycle.

Our top picks in the early stages of this new gold rally are Agnico Eagle (AGE-TSX, AEM-NYSE) (www.agnico-eagle.com, 416-947-1212); Glamis Gold Ltd. (GLG-TSX, NYSE) (www.glamis.com, 702-827-4600); and, South African's Gold Fields Ltd. (GFI-NYSE) (www.goldfields.co.za, 303-796-8683) and Durban Rooderpoort Deep (DROOY-NASDAQ) (www.drd.co.za, 212-815-5133). The strong South African Rand hurt the South African stocks in 2003 but the Rand has reversed course and appears weak against the US$. We expect this weakness to prevail going forward and South African gold stocks will be well positioned to outperform in the next leg up.

May 31, 2004
David Chapman

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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