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Tactical Gold Trends

Adam Hamilton
July 9, 2004

After a psychologically-challenging first half of 2004, gold has gloriously entered the second half with a dazzling display of strength this week. The Ancient Metal of Kings is powering higher and extending its bull market that was quietly born over three years ago. It is a wonderful blessing to behold!

While it is natural to feel good this week if you are long the precious-metals complex, it is still important to temper our emotions as investors and speculators. Just as gold sentiment darkens after a few down days as fear rises, sentiment is shining today as greed begins to swell after a few nice up days. And greed and fear are always counterproductive and cloud trading judgment.

Day-to-day movements, although exciting at times, can best be viewed dispassionately by placing them into their proper context within ongoing price trends. Whether we witness a depressing string of down days as in early June or a fantastic streak of up days like this week, daily movements are really irrelevant in isolation. The true importance of price action only becomes apparent when considered within the dominant trends.

In this essay I would like to discuss these current prevailing gold trends. I am also very excited about the prospects for gold and gold stocks this week, but not because we were blessed with some nice daily gains. I am bullish because the tactical gold trends are undisputedly positive once again, for the first time since last year, clearing the way for the next major upleg in gold.

An understanding of these trends is very important because it trumps day-to-day action and helps keep investors and speculators on an even emotional keel. Even if gold had fallen $10 this week instead of surging, leading to growing fear, the powerful bullish message of these trend charts would not have changed one bit. They provide the big-picture framework that keeps the daily swings, both in and out of our favor, emotionally manageable in their proper context.

Our three charts this week detail the current tactical trends in gold, the US dollar, and gold stocks. Each graph runs back to November and encompasses two major short-term trend changes marked by fulcrums. The key 50 and 200-day moving averages and 50-day 2.5-standard deviation Bollinger Bands are drawn in. Also, each price divided by its 200dma, the relative price, is rendered in red on the left axes to normalize the distance between each price and its key 200dma support or resistance.

Daily market noise aside, these charts clearly show that the tactical gold trends have become very bullish and gold appears to be already entering its fifth major upleg in its bull market to date. Just as in its previous four major uplegs, I suspect vast profits will be earned by the prudent contrarians willing to ride gold higher this time around.

Strategically, there is no doubt that gold is in a primary bull market. >From its lows near $255 in April 2001 to its highs over $425 in January, gold has already blasted 66% higher. Even though its long-term trend driven by global supply and demand remains bullish, over the short term it advances in powerful uplegs and then inevitably corrects for a season. Two steps forward, one step back.

These tactical movements are driven by speculator emotions. When greed waxes too ecstatic at the top of a major upleg gold corrects, and when fear grows too overwhelming at the abyss of a major correction gold rallies. The wave-like nature of tactical trends oscillating around a strategic trend is a natural market reaction that regulates general sentiment and self-corrects when either greed or fear threaten to spiral out of hand.

In this gold graph, greed was getting silly in early January and a correction was due. Gold was overbought, gold bears were ridiculed by the gold community, and irrational predictions about $500 gold falling within weeks abounded at the time. Greed had simply grown too great so the gold bull market needed to correct to bring back a sentiment balance among speculators. This turning point of the short-term trend, from upleg to correction, is quite evident above.

Once gold started correcting, it carved a new tactical downtrend channel during the first four months of 2004. With the notable exception of the late-March gold rally, which seemed quite anomalous at the time since there wasn't a corresponding inverse move in the US dollar, gold continued to correct and bleed off greed. In April this dollar-decoupled gold spike promptly crashed right back down into gold's downtrend channel. These were not happy times for gold players and negative sentiment was ballooning.

The longer that this tactical downtrend persisted, the more negative technical analysts became and the more fear built up in the gold market. By late April all kinds of doomsday talk was swirling around gold and fear was becoming extreme. Dire predictions of gold falling under $350 and even $300 were everywhere and gold analysts and investors alike were jumping all over themselves to declare the bull market in gold over. The gold correction had deftly accomplished exactly what it set out to do, shift general sentiment from greed to fear.

By early May, this surging fear was growing so intense that gold was hammered down to $375 in a final capitulation. Yet, by this point general fear was as widespread as it was going to get during a secular gold bull. Provocatively gold fell right down to its correction support line in May right before rapidly bouncing higher and never looking back. The prevailing tactical gold trend had changed back to positive, although no one knew it for certain at the time.

While we cannot often know in real-time when a tactical trend is changing, there are all kinds of signs that let us know to anticipate an imminent trend change. I was looking for this trend change and wrote about it extensively in late April, a little early. In "The Relative Dollar and Gold 2" on April 23rd I concluded, "Another major gold upleg appears to be on the very verge of launching, but only the decisive and brave will seize today's awesome opportunity to saddle up and ride it. Get long now!"

After bouncing one last time off its correction support line at the capitulation bottom in early May, gold surged higher off the trend-change fulcrum above. It ended up carving a pattern well known to technical analysts, a sharp V-bounce. V-bounces are sharp rallies that follow sharp capitulation corrections and are a signature pattern that often marks the birth of major new uplegs or rallies in a market. On May 28th I wrote, "Periodic sharp corrections in bull markets are healthy and expected, and that is exactly what we have just witnessed in gold stocks."

Yet, even in late May after the V-bounce appeared on the charts, we still didn't have any tactical technical uptrend to lean on yet. After the V, gold struggled with its key 200dma as overhead resistance, which is not an encouraging sign in a primary bull market when the 200dma is supposed to act as major support. The short-term 200dma failure once again spooked battle-weary gold players and gold was sold again. But then something very exciting happened.

Rather than plummet way back down to a lower low under $375 and keep its correction downtrend intact, gold carved a higher low. In the middle of June it caught a bid again and surged back above the psychologically crucial $400 level as well as its 200dma, a very important event technically. It peaked at a higher high in late June and then pulled back slightly to consolidate its gains.

Now if you weren't paying attention to the gold charts with a six-month-or-so time horizon in recent months, it would have been easy to get psychologically buffeted by all the vacillating trading action. Gold was moving day-to-day like a jackhammer, taking speculators on a rollercoaster ride from daily fear to greed and back again. It was enough to make one queasy! But, during all this seemingly jumbled day-to-day market noise, an awesomely bullish picture was being painted on the tactical charts.

From its early May capitulation V-bounce to its mid-June pullback, gold announced a new level of support to technically-oriented speculators. A straight line connecting these two more recent interim lows is drawn above. A parallel line drawn higher intersects gold's two most recent interim highs, late May and late June. Together these two ascending technical lines form an uptrend, a series of higher lows and higher highs. And this new uptrend is very solid technically with four major intersects on its pipe walls since early May.

For the first time since last year when gold was in a major and immensely profitable bull-market upleg, we are now seeing the early evidence of a new uptrend. This is very exciting to me as I believe it represents the early stages of the fifth major upleg in gold! If I am right, then enormous profits will be earned by gold investors and speculators in the second half of this year. This new uptrend also drives the final nails into the coffin of the demoralizing correction that we suffered through in the first half of 2004.

As you ponder this chart, realize that this week's price action would have made no difference either way. If gold had fallen instead of surged, it may have bounced near its lower support line but the uptrend would still have been intact. One of the most important reasons for watching the charts is to keep considering daily price movements within their proper context to help suppress soaring greed on up days and welling fear on down days.

Daily price action, when considered in isolation out of its trend context, is usually meaningless. It makes no difference at all whether gold is up 1% or down 1% tomorrow, for example. All that matters is how the next daily move fits into the existing trends.

This resurgent gold uptrend, as well as its preceding correction, is intimately tied with the inverse trading action of its old nemesis the US dollar. As such, I would be remiss to discuss tactical gold trends without considering the tactical dollar trends that tend to drive gold over the short term. The very bullish case for gold is strongly buttressed by the renewed weakness in the once mighty US dollar.

Unlike gold, the dollar is languishing in a secular bear market for fundamental reasons. While bull markets oscillate around their primary uptrend with periodic uplegs and corrections, bear markets oscillate around their primary downtrend as well. Naturally, their behavior is inverted compared to bull markets. If you can, it is useful to view our first gold graph and this dollar graph side-by-side to fully grasp this important market truism.

Bear markets' big movements down are known as downlegs and their periodic countertrend "corrections" are known as bear-market rallies. Downlegs fall until fear grows too great at the bottom, then a bear-market rally launches out of a V-bounce. Once general greed waxes too ecstatic at the top, the bear-market rally fails and a new downleg begins. Tactical oscillations within strategic bears are also driven almost exclusively by speculator emotions.

Just as gold was topping in early January, the US Dollar Index was bottoming. If you recall as 2004 dawned, shorting the dollar was considered a surefire bet at the time and there were just too many people piled onto the short side. In addition the dollar had been plunging relentlessly late in 2003 and was very oversold. This stretched dollar condition provided an ideal spawning ground to spark a major bear-market rally. The rising prospect for a major dollar rally was the primary reason I was neutral on gold and expecting a correction at the time.

Sure enough the dollar surged, carving a major V-bounce on its chart. Just as in the gold-bull example above, a V-bounce in a bear market is also a harbinger of a short-term trend change into bear-market rally mode. The dollar sputtered a bit initially in February, but then soon started climbing and created a gorgeous tactical uptrend channel. Its support was briefly broken on a couple occasions, but on a best-fit basis the bottom of this trend pipe was still quite solid.

Remember above when I mentioned the March anomaly in gold? Gold surged in late March but as this dollar chart shows the dollar did not materially fall at the same time. This was a cautionary signal that warned speculators that gold probably had not really reached its correction bottom yet in early March since the dollar's own short-term trend had not yet changed. As the dollar surged again in April, gold's anomalous March spike crashed and ushered in the terribly negative psychology necessary for a gold capitulation.

The dollar's bear-market rally peaked in early May, at the exact same time when gold's capitulation bottom was being carved! Since gold and the dollar are essentially competing currencies, it is not surprising that they can inversely mirror each other so precisely at key interim turning points. If you carefully examine this dollar chart since the May interim top, you can see why the dollar is confirming a major new upleg in gold.

In May, just like with gold, the dollar's tactical trend changed. The dollar started decaying. Each new high was lower than the preceding one and each new low was lower. Lower highs and lower lows make a downtrend. The support and resistance lines for this new dollar downtrend are drawn in above. The support line has multiple intercepts and the parallel top resistance line is fairly solid too with one intercept and three near intercepts. This dollar downtrend is the real deal, the first since 2003 in tactical terms.

Another point to note is the dollar is now bouncing off its 200dma as overhead resistance. The 200dma forms the most fundamental technical support level in a major bull and resistance level in a major bear. The fact that the dollar could not hold above its 200dma in May is immensely bearish and the subsequent failure at its 200dma in June drives home this point. A new dollar downleg is underway, which is fantastically bullish for gold.

When both the tactical gold trends and dollar trends are considered together, the case for a major new gold upleg brewing becomes very strong. All of the technical ingredients are now in place for gold to soar into the second half of 2004, election or not. And if gold does indeed do us proud with its fifth major upleg in its bull to date, the primary beneficiary for speculators will be the elite quality unhedged gold stocks of the HUI.

Interestingly, even the tactical gold-stock trends have turned bullish as more and more gold investors and speculators realize how dazzlingly bright gold's fundamental and technical pictures look today.

Not surprisingly, the HUI's tactical trend pattern looks very similar to gold's, albeit with slightly different timing of the fulcrum turning points. Gold stocks topped in early December 2003 before entering a demoralizing correction for the next four months to bleed off the excessive greed of late last year. They failed to confirm the anomalous March rally in gold as they couldn't carve a marginally higher high, another warning sign to speculators.

Once the HUI's correction support line failed in mid-April, an inferno of fear ignited and drove a brutal capitulation panic. By early May popular fear in gold stocks was extraordinary, the greatest we have witnessed in this bull to date by far. At the time I read one report where an analyst was actually publicly predicting a 90% fall in gold stocks, back down to below their November 2000 levels when their gold bull launched! Talk about scary!

Whenever fear reaches these silly extremes, when all anyone can see is black losses extending out past the horizon, the markets attempt to balance out this sentiment overreaction by rallying. And right at the fulcrum in early May the HUI soared and left a sharp V-bounce on the charts, once again a telltale marker of a major tactical trend change. This initial surge failed near the HUI's 50dma, but the subsequent pullback ended at a higher low, which was encouraging.

The V-bounce bottom in May and this higher secondary bottom in June formed the intercepts for the support line of a new tactical uptrend. A parallel top resistance line only has one intercept so far, but the way gold stocks are moving this week I don't think it will be too long at all before a second higher HUI high is achieved and this young trend channel is fleshed out. And a series of higher lows and higher highs is exactly what we would expect early in a major new gold-stock upleg.

From a tactical gold trends perspective, I could hardly imagine a more bullish way to kick off the second half of 2004. Gold is carving a new uptrend following its expected correction, and gold stocks are acting the same way but a bit more tentatively as most speculators are still unwilling to believe at this point. It is good to see gold stocks climbing a wall of worry though as skepticism is normal after major interim bottoms.

Meanwhile the mighty US dollar, gold's trading nemesis, has topped out in its major bear-market rally and is now establishing a new downtrend channel. The primary beneficiary of dollar weakness in its continuing Great Bear never fails to be gold. Not only is gold looking good, but the dollar is looking bad, which is the best of all worlds for gold investors and speculators.

If you are interested in playing this growing gold upleg, please consider subscribing to our acclaimed monthly Zeal Intelligence newsletter and supporting our research work at Zeal.

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The July letter, complimentary to new e-mail subscribers, also discusses potential probable upleg targets for this fifth gold upleg, both in terms of gold prices and upleg duration. I also weigh in on the extremely controversial issue of whether or not gold stocks are likely to be adversely manipulated leading into the US presidential elections this autumn, among other topics.

With the tactical gold trends turning up while the dollar trends decay lower, it sure looks like another major gold upleg is already underway. For prudent contrarians willing to heed the early technical signs and deploy capital before this thing really gets moving, vast potential profits probably await in the second half of 2004.

July 9, 2004
Adam Hamilton, CPA
email: zelotes@zealllc.com

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