Relative Gold Bulls 2
Adam Hamilton
Archives
May 19, 2006
This past week has been rather
traumatic for gold investors. Just two days after achieving dazzling
quarter-century nominal highs above $720, gold had fallen 5%.
Retreating prices irritate investors to no end, so there is now
an increasingly vitriolic war of words underway in the contrarian
community about whether we are now witnessing the early days
of a full-blown correction, merely a minor pullback, or an irrelevant
blip.
While my long-term gold-heavy
investment portfolio is certainly feeling the pain, the speculator
in me loves volatility regardless of its direction. Volatility
is the lifeblood of speculation, it grants us priceless opportunities
to buy low and sell high. If markets ever only rose in a slow
and perfectly orderly manner, speculation would cease to exist
as only investment would be possible. What a boring and dreary
soul-crushing world that would be!
Investors, and indeed most
folks, generally view speculators with scorn. Whenever prices
move in any direction they don't like, speculators get the blame.
A decade ago this used to bother me, but now I love telling people
I am a speculator just to savor their reaction. After finding
out what I do they'll often say something like, "So, high
gas prices are your fault." To which I reply, "Darned
right amigo! I own the best oil companies pumping the oil, I
own the elite refineries distilling it into gasoline, and I think
gas is way too cheap at $3." Perhaps this is why speculators
aren't popular at cocktail parties.
In reality prices are not "the
fault of" speculators. We are the most essential lubricant
to the free markets, willingly putting our hard-earned capital
and necks on the line time and time again to provide critical
liquidity when no one else will. Who was buying gold last
June when it languished under its 200dma and threatened to
fall under $400? Speculators. Who cares if we are despised as
long as we are earning huge profits!
Why am I leading off with this
discussion? In the last week a pernicious campaign is taking
shape to ridicule every speculator who even believes a correction
in gold is merely possible. We speculators are being called idiots
and morons. It is pretty funny really. The most amusing and comical
part is that the opposing position, that a gold correction is
impossible, is sheer lunacy based on market history. No bull
markets, no matter how powerful or how compelling their fundamentals,
ever advance up in an accelerating uninterrupted line.
Another new fallacious assault
on speculators claims successful speculation in gold is impossible.
Lies, damned lies! I've written several hundred essays in the
past six years mostly about commodities including gold and have
accurately called most of gold's major interim tops and bottoms
in real-time near where they happened. My record
is public and can easily be compared to gold's major uplegs
and corrections so far. The late
2004 gold top? The early
2003 gold bottom? Last week's dollar-rally-driven
gold selloff? All anticipated in advance. Speculators were
all over these tactical reversals and earned fortunes trading
them.
So whether you are an investor
or speculator, and each approach to the markets has advantages
and disadvantages, realize that it is just plain silly to make
foolish statements totally unsupported by history such as "corrections
are impossible" or "successful gold speculation is
impossible". Making any such absolute statement in a purely
probabilistic market environment where anything can happen at
any time simply highlights the naivety of those who dare utter
such nonsense.
If you are a speculator you
realize the huge importance of analyzing markets and looking
for corrections. We live for volatility and love corrections
as they provide us a dazzling buying opportunity for gold, silver,
and PM stocks once they fully run their courses. But investors
benefit tremendously from corrections too. If you are a pure
long-term investor and you want to add more capital to these
precious metals bulls, the ideal time to do it is right after
a correction when prices are relatively low. Anticipating corrections
greatly benefits investors.
With this background in mind
and ignoring the fools who think markets rise in straight lines
forever, two important questions about gold occupied my mind
this week. First, and most importantly, is another major gold
correction likely now underway as we have seen about a half-dozen
times before in this gold bull or are we just witnessing a minor
pullback?
Second, with gold the most
technically overextended last week that it has been since its
last Stage Three blowoff in early 1980, what are the odds Stage
Three is here again? This is a crucial question with double-edged
implications. If we are now in Stage Three, gold could continue
blasting straight up to $5000
or so, but that would be it, this gold bull would be over.
But if we aren't in Stage Three yet, then gold is not going to
continue its vertical ascent, it will correct, but on the bright
side there will probably be many more years left in this bull.
In order to frame my inquiry
into these questions, I decided to view it in Relativity terms.
Relativity is a trading
theory I developed after spending many years studying current
and historical markets. All secular bull markets in history flow
and ebb, experiencing awesome uplegs followed by sharp corrections.
Mathematically the uplegs stretch prices far above their 200-day
moving averages and then the following corrections drag them
back down to their 200dmas.
This perpetual oscillation
away from and back to a bull's 200dma can be quantified by dividing
a price, the gold price, by its 200dma. The resulting relative
trading range expresses gold as a constant multiple of its 200dma
over time. Charting this creates a probabilistic trading band
showing how likely gold is to surge or correct at any given time.
By comparing Relative Gold today with rGold in the early 1970s,
the last time gold was transitioning
into Stage Two, we can gain an idea of how today's gold bull
is faring relative to history.
The last time I wrote on the
entire modern history of rGold was over
two years ago. If you read that earlier essay and compare
it to this one, you may notice slight differences in extreme
rGold highs and lows. This is because I am now using a new daily
gold dataset we hadn't yet purchased the first time I did this
study. Believe it or not all historical datasets, regardless
of their price, contain some dirty and incorrect data. I think
this new dataset is cleaner than our old one though so I am using
it for historical gold analysis going forward.
For both investors and speculators
perspective is absolutely crucial, and this long-term gold chart
with over 65,000 individual data points graphed really puts gold's
latest fantastic upleg into context. The red numbers are extreme
rGold values at various points in time while the blue numbers
mark the three
major stages of each great gold bull.
The first thing about this
chart that is striking is how high gold looks today compared
to its late 1970s super spike. This is quite deceiving though.
If you adjust gold for inflation and chart
it in real terms, gold is now merely trading at its same
levels of the late 1980s. Gold's all-time nominal high in January
1980 expressed in today's increasingly inflated US dollars is
near $2200. So within the scope of an entire secular bull, $700
gold today is nothing and not even close yet to the real highs
of a quarter century ago.
Nevertheless, except during
its final terminal blowoff in Stage Three of the 1970s gold superbull,
gold certainly didn't move up in a straight line without interruption
and neither has our current specimen. Check out the red rGold
line in the 1970s. Gold alternatively rocketed higher in uplegs
that utterly dwarf anything we have seen so far today but then
it collapsed back down to its 200dma (1.00 rGold) in brutal corrections.
Even despite this extreme volatility, the 1970s bull is still
fondly remembered today as the greatest gold bull in history.
What really captured my attention
last week, and I wrote a Zeal
Speculator Update on it at the time for our ZS subscribers,
was how far gold had soared above its 200dma lately. On Thursday
May 11th gold closed at 1.389x its 200dma. Students of the markets
who understand gold's behavior over the last 35 years or so were
stunned. Gold hadn't extended anywhere close to this far above
its 200dma since its 1979 Stage-Three-blowoff super spike!
This was very concerning. Every
week I get e-mails from folks who want Stage Three to be here,
to see the mainstream public rush into gold like they did into
the NASDAQ in 1999 and drive it to the moon. Yes it would be
fun and we would all earn fortunes, but the problem with a premature
Stage Three terminal parabola is that it will mark the end of
this secular gold bull. Once the entire public buys gold, there
will be no one left to buy and gold prices will collapse like
they did in the early 1980s.
Another problem is that the
earlier a bull transitions into Stage Three, the smaller its
final Stage Three spike will be. Most secular bulls run a decade
to 17 years
in duration, which is plenty of time for average folks to become
aware of the vast riches that are being won in them. The longer
a bull lingers in Stage Two, the investment-driven stage, the
more people will become aware enough of it to ultimately buy
in eventually driving a far higher Stage Three blowoff. The later
that Stage Three drives gold terminal this time around, the exponentially
higher the profits we will earn. We don't want a premature and
anemic Stage Three.
And with our current gold bull
just 5 years old, very young still, there are major fundamental
and psychological reasons why Stage Three should be many years
away yet. Fundamentally Stage Three typically doesn't happen
until worldwide mined-gold supply exceeds demand, and we aren't
even close yet. It takes many years for gold miners to bring
new gold to market to respond to rising prices, it is a very
slow process. And psychologically gold remains unpopular among
mainstreamers. Until we hear everyone talking about gold all
the time like they talked about tech stocks all the time in late
1999, it is too early psychologically for Stage Three.
When all these factors are
added to the key fact that inflation-adjusted gold is still less
than one-third of its way to its all-time January 1980 real highs,
the odds of this latest gold surge being early Stage Three days
are phenomenally low. But if Stage Three isn't upon us, then
why is rGold stretched to unbelievable Stage Three levels? This
question was bothering me until I created this chart.
It turns out, amazingly enough,
that three decades ago in the last great gold bull's own early
Stage Two years, rGold soared above today's levels three times
in three different major uplegs! Thus enormously stretched rGold
extremes are not only witnessed in Stage Three, but in Stage
Two as well. I was really excited to learn this because it not
only corroborates other technical
evidence that we are indeed in Stage Two, but it shows that
this degree of huge upleg is normal in Stage Two!
Huge rGold spikes do not only
happen during the Stage Three parabolic blowoff! This next chart
zooms into the early and mid-1970s gold data and really illustrates
this fascinating and encouraging point. While our current gold
bull certainly won't unfold exactly like the last one, more often
than not current market events at least rhyme with history so
history helps us understand what kind of volatility we should
expect.
In the early 1970s gold languished
in a modest Stage One uptrend, not doing much of anything. Of
course it was illegal for American investors to own bullion gold
until early 1975 which certainly put a damper on gold's early
1970s progress. But in mid-1972, less than a year after Nixon
reneged on the international dollar gold standard, gold gloriously
broke out of its Stage One channel. Its first Stage Two upleg
drove it up 36% after this breakout in just 43 trading days,
blasting gold up to 1.390x its 200dma.
These numbers are just wild
technically. Why? Our latest gold upleg today, which is no doubt
the first in Stage Two of our current bull market, is up 34%
from its March lows, after its breakout, over 43 trading days.
This unprecedented surge, for this bull at least, catapulted
gold up to 1.389x its 200dma. Déjà vu? While I
am going to discuss this more after the next chart, drink in
these two separate initial-Stage-Two-upleg metrics separated
by nearly a quarter century and marvel at how technically close
they are statistically. Wow.
And for those who think gold
is going terminally parabolic today, I really doubt it. I made
another chart, which didn't make the cut for this essay, which
graphs gold's Stage One run in the early 1970s up until the end
of its first major Stage Two upleg in mid-1972. That chart looked
almost identical in slope terms to the chart below of our current
gold bull. Thus what may look like a parabolic gain now will
probably look as small a few years from now as this 1972 upleg
does in the context of the early Stage Two years of the 1970s
gold bull.
Incredibly in the 1970s the
Stage Two uplegs got even better after the initial one in 1972.
The next upleg in 1973 blasted 108% higher, the following one
ending in early 1974 advanced another 94%, and the last one in
this series ending in late 1974 was still up 46%. The 108% and
94% uplegs were so fast and volatile that they dragged gold over
1.50x above its 200dma!
So today's stellar rGold levels
may very well be handily exceeded in the coming Stage Two uplegs
in the years ahead. Talk about big gains, if gold continues following
its early-1970s script this time around then we ain't seen nothing
yet!
Now these gigantic Stage Two
uplegs last time around created a hyper-volatile Stage Two uptrend
channel vastly steeper than anything that came before it. And
while it is certainly fun to examine the 1970s Stage Two uplegs
and imagine what wonders probably lay before us in Stage Two
of our own gold bull, there is one crucial point that neither
investors nor speculators should overlook.
After every single massive
Stage Two upleg in what is today universally considered the greatest
gold bull ever, gold corrected back down to its 200dma. Yes I
used the c-word! Correction. These healthy plunges necessary
to rebalance sentiment and prolong the bull's ultimate life were
roughly proportionate with the uplegs that went immediately before
them. The bigger the preceding upleg, generally the sharper and
more vicious the following correction.
Thus in Stage Two, while we
can expect far bigger uplegs than anything we have yet witnessed,
the cost of these uplegs is the sharp corrections on the other
side. These corrections do not hurt the bull and gold should
continue to march higher on balance, but it will not march up
in a straight line. No bull market in history ever has until
its final terminal parabola.
So the folks today calling
speculators who expected a gold correction idiots or morons have
really misplaced their vitriol. Rather than wasting time attacking
speculators just as bullish on gold as they are, they ought to
be studying market history so they don't make fools of themselves.
The next crucial point from
the lessons of the last Stage Two gold bull involves the depth
of these periodic corrections. Every single one saw gold return
all the way back down near its 200dma. Sometimes gold bounced
right above its 200dma to launch its next upleg and other times
it sank a bit under its 200dma, but overall the 200dma was a
good correction target during the last Stage Two.
Now since I apparently have
to be an idiot and moron to actually expect markets today to
work like markets always do, perpetually driven by the same competing
emotions of greed and fear, let me escalate my blasphemy. If
gold corrected to near its 200dma in the last Stage Two no less
than every single time, isn't there at least some small chance
that it will correct to its 200dma today after its first Stage
Two upleg this time around? If so, then we are in for one wicked
correction, because today gold's 200dma is under $525!
Now check out gold's Stage
Two transition today after understanding how Stage Two worked
a quarter of a century ago. From the initial modest Stage One
uptrend to the dazzling breakout to the amazing initial Stage
Two upleg, the similarities here are uncanny. So far gold is
pretty much doing what it did last time around.
Measuring this first dazzling
Stage Two upleg is somewhat ambiguous. If we consider it as beginning
way back at its 200dma last summer when gold threatened to plunge
below $400 and investors were scared, it is up 74%. But if we
instead just measure it from its latest mid-March lows after
its breakout before it rocketed vertical, it is up 34% and in
line with its 1972 initial-Stage-Two-upleg ancestor. Either way,
this first Stage Two upleg is obviously vastly different in magnitude
from its Stage One predecessors.
One key implication for speculators
is this new Stage Two has just shattered our existing rGold trading
range. For years now at Zeal we have been watching an rGold range
running between 0.99 on the low side to 1.14 on the high side.
When gold fell near the bottom of this range near its 200dma
it had been an awesome buy for both investors and speculators
and when gold hit or exceeded the top it was time to expect a
correction and trade accordingly for speculators.
Based on my look at the Stage
Two of the 1970s I think our lower rGold strong-buy zone of 0.99
is just fine going forward, but obviously gold trading at 1.14x
its 200dma on the top end is far too conservative. I'll be closely
watching gold's coming uplegs and using them to attempt to recalibrate
the top of our rGold scale for Stage Two. With only one Stage
Two upleg under our belts it is too early yet to make a guess,
but the new Stage Two rGold neutral zone is no doubt going to
be much higher than it was in Stage One.
This rGold trading range in
Stage One rendered above is one of the key tools we used at Zeal
to trade gold stocks over the past five years. We generally bought
gold stocks when gold was near its 200dma and ratcheted up our
trailing stops when gold was stretched far above its 200dma,
with great success.
While we certainly didn't catch
major interim tops and bottoms to the very day, we were pretty
close most of the time and our subscribers thrived. They bought
low and got stopped out high for big realized profits, over and
over again. People today who say it is impossible to trade gold
apparently weren't successfully doing it throughout this entire
bull, they are flat-out wrong. Periodic corrections in powerful
bulls are normal, healthy, inevitable, and anticipatable and
it flabbergasts me when investors refuse to acknowledge this.
One of the most common anti-correction
arguments is the Black Swan. In trading, a black swan is an ultra-rare
event that radically moves markets but cannot be anticipated.
Think 9/11 for example. People always tell me that if X happens
then gold is going to the moon. I almost always agree with them.
If X happens, if Washington is nuked, if the dollar hyper-inflates,
if Martians invade, if whatever, gold will indeed go to the moon.
But the problem is X is always an ultra-low-probability black-swan
event.
Prudent speculators trade based
on high-probability events like the normal flowing and ebbing
of the markets for sentiment reasons, not worst-case scenarios.
All prudent speculators also have long-term gold investments
in a separate portfolio that they don't actively trade just in
case, but they never bet their speculative capital on ultra-low-probability
black-swan events. These just don't happen often enough to actively
game.
At Zeal we intimately understand
the markets are governed by probabilities so we align our trades
and trading recommendations for our subscribers with the strongest
prevailing probabilities. After gold rockets vertically at the
end of a massive year-long upleg, the odds definitely favor a
correction. These corrections are huge opportunities though as
the bargains at their ends are the best deals investors and speculators
alike are ever going to see in the midst of a powerful secular
bull market.
While we have successfully
traded every major gold and gold-stock upleg in this bull to
date, we have never spent as much time preparing for the next
buying opportunities near 200dmas as we have in recent months.
If you want to buy the next round of elite gold miners with awesome
fundamentals near their technical bottoms after this correction
runs its course, please
subscribe to our acclaimed monthly Zeal
Intelligence newsletter today. And make sure you have cash
in your trading accounts for the feast to come!
The bottom line is all bull
markets, no matter how powerful they are or how compelling their
fundamentals happen to be, flow and ebb. Periodic corrections
are just as inevitable as massive uplegs and they must be expected
from time to time. These episodes of weakness are very important
for the bull's ultimate health and longevity as they keep greed
in check and rebalance sentiment.
If someone has duped you into
believing that corrections in gold are impossible, you are likely
going to lose money and burn out fast. Corrections will indeed
arrive anyway and can rip your psyche apart if you weren't expecting
them from time to time. Please study market history to gird yourself
against the rantings of ignorant fools, for the markets take
no prisoners.
Adam Hamilton, CPA
May 19, 2006
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
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