Is This It?
We have had a good run in the precious metals stocks over the past few weeks, and with gold within sniffing distance of its highs at $430, and the junior and exploration stocks starting to regain consciousness, the big question concerning us now is "Is this it?" - are we now going to see the long-awaited breakout and major uptrend that many are expecting?
The short answer is yes - I believe we are, and it could be spectacular, but there is one major hurdle remaining to be cleared. This hurdle is the synchronous failure of 87 on the dollar index and breakouts by copper above $1.40, gold above $430, silver above $7.00 and the HUI index above 260. You will see why I bring copper into the equation later, when we look at its chart.
First let's consider a political reality. Markets have for the most part been remarkably tranquil and steady over the past few months, with the VIX index, an indicator of volatility, being at an exceptionally low level for some time. This is just what the incumbent administration wants - they want voters to feel as comfortable and complacent as possible when they go to the polls, to maximize their chances of re-election. Crashing stockmarkets and a plunging dollar do not create much of a "feel good factor" in most voters. Rather than sitting idly by and just hoping that markets will play ball, many observers are of the view that the government are actively involved in massaging markets to achieve the desired effect, of intervening heavily to manipulate markets. They certainly have the resources to do this over a short and medium-term timeframe, even if it results in distortions in the economy, but in the case of a massive internationalised market such as US dollar trading, they would not be able to control its course indefinitely.
Fortunately for them, they don't need to. One more month will be quite sufficient. After they are re-elected on 2nd November, and entrenched for another 4 years, they couldn't care less what happens to it. What this means is that, to whatever extent they are propping up the dollar in an effort to stop it plunging pre-election, this support can be expected to vanish on 3rd November. It is therefore likely that the dollar will remain above its critical support at 87 on the index during October, with a good chance that it will break down early next month. This has obvious timing implications for precious metal share investors.
Now let's look at the synchronous breakout points on the charts, starting with the all-important US dollar. The 1-year chart shows the dollar weakening, having broken down from a symmetrical triangle formation that developed from mid-late July. Whilst within this triangle there was some danger of an upside break, as the index was nudging the long-term downtrend line. With the breakdown a couple of weeks ago, the chance of significant upside action is greatly reduced. The dollar is now threatening to break down below the important 87 support level, and while there is another support level at 85, once 87 breaks the prospect is of an eventual decline to the lower trendline, which is off the bottom of the longer-term 3-year chart shown. This is a long drop. As indicated above it is believed that "they" will try to hold the 87 level until the election.
Turning now to gold, we see that it has advanced again within the relatively shallow uptrend channel that began last May, shown on the 6-month chart, and, reflecting dollar weakness, is already at $419 - not far beneath the key resistance arising from last winter's double-top at $430. A point to note here is that, should it go on to break above $430, the rate of rise is expected to accelerate significantly, so that the uptrend channel shown on the 6-month chart will be obsolete - it will break out of it on the upside. The target for the move following a breakout above $430 can be deduced from the long-term trend channel shown on the 3-year chart - if it rises to the top line of the channel it will reach about $480. Short-term, that is to say pre-election, gold may back off some as "they" pull out all the stops to try to prevent the dollar from breaking below 87.
Silver has performed very well over the past week or so with its rate of rise accelerating, and has now come hard up against a major resistance level at $7. Silver has had a marked tendency this year to rise steadily, but fall very hard and fast, and there is now clearly the risk of a sharp short-term reaction, even if it goes on to take out this resistance. As a trader I would be an automatic seller at this level, buying back on a short, sharp reaction, or immediately reversing position should it break straight through the key $7 resistance. The 2-year chart for silver is encouraging, showing the price being shepherded higher by an accelerating parabolic uptrend. The importance of the $7 resistance level is very clear on this chart, and it is obvious that a powerful advance is likely to follow once this level has been overcome.
The copper chart is featured in this article, as it provides important additional corroborative evidence that we are close to a broad based breakout in metals prices, and also because many of the stocks in which we have an interest, such as Freeport McMoran, are also copper producers.
Copper is at a critical juncture, it is right at the point of breaking out above the highs it attained early in the year at $1.40. Clearly it could form a double-top here, but I don't believe that is likely, for other reasons, mainly that the US dollar looks set to tank. Our 3-year chart shows copper's powerful advance clearly and also how the reaction mid-year was caught by the 200-day moving average, which has since shepherded the price back up to the highs. Again, this is likely to stall or react short-term before it takes out the highs. Once these highs fall copper is expected to advance strongly.
Gold stocks have advanced strongly over the past couple of weeks, as shown by the 1-year chart for the HUI index. Although this rise in the stocks has reflected the rise in the gold price, it is nevertheless impressive, as gold has not risen that much, $10 or so, and stocks are having to work their way through a significant resistance zone. The breakout by gold above $430 is likely to synchronize with, or be closely accompanied by, a breakout by stocks to new highs, meaning a breakout by the HUI index above its earlier highs towards 260. The HUI index is expected to need to rest or consolidate beneath the strong resistance towards 260 to build the strength need to take out this resistance decisively. Thus, we are likely to see either a continued advance into the 240 - 260 area, followed by a pause of perhaps several weeks, or a slower, more hesitant advance into this zone, both scenarios serving to reduce the overbought condition of the index before its expected assault on the highs.
There are two main strategies for would-be gold share investors to play this situation. One is to wait for the breakouts and then quickly take positions. This is safer in the sense that the markets will have then declared themselves, with the chance of them going into retreat greatly reduced. This approach, however, foregoes the considerable gains that will accompany the breakouts, as once gold breaks above $430 everybody will be piling in and prices will rise steeply. The other approach is to selectively buy pre-breakout, defining and limiting risk by setting exit points so that should the expected breakouts not materialize, losses are limited.
On my site www.clivemaund.com the focus is on selecting stocks with a very favourable risk/reward ratio, our ideal candidates being those with nearby support, limited overhead resistance and big upside potential.
3 October, 2004
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