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 MARKET REPORTS |
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Analyst report
Gold hasn't lost its glitter
Enrico Orlandini - September 3, 2007
 It’s been a while since I’ve written exclusively about gold but there seems to be a lot of uncertainty in the market place so this should be of interest to most of you. I have a number of clients who have significant positions in gold ETF’s (exchange traded funds), have held them for a year or more, and are worried. They’re worried because it has been widely disseminated by the press that gold was being sold off as investors seek a safe haven from sub-prime woes.
This of course is absurd and flies in the face of five thousand years of history, but then again what can you expect from modern day reporters who think Edward R. Murrow designs cloths for Gucci. Earlier this month gold declined for two very simple reasons: traders caught on the wrong side of declining stocks, as well as the carry trade, needed liquidity in a hurry. Then throw in a dash of manipulation and you have the complete picture. These two forces combined on August 16th, producing a very ugly session where the December gold futures contract took a nasty fall, declining 21.70 to close at 655.20. You could just sense the despair as gold bugs threw in the towel with those famous words “never again”. In my particular case, I had never received as many e-mails denouncing gold as I did that day.
Admittedly gold did suffer some technical damage when looked at from a short term perspective, but it wasn’t the end of the world type of damage that you can’t recover from. December gold did somehow manage to hold strong Fibonacci support at 650.50 and finished the session at 658.00. The next day December gold fell again on the open, testing the 650.50 support for the second time, before bargain hunters stepped in and closed the contract at 666.80. Since then it’s been climbing a wall of worry made even slipperier by a press that can’t wait to talk it down. Whenever I see such conditions, I like to take a look at the reality of the situation, and the best way to do that is with gold’s monthly chart:
Even the most ardent bear would be hard pressed to find fault with this chart. As you can see gold is still trending up while using the fourteen month average as support. For those few investors who were savvy enough to buy gold back in 2001 and still hold it, I suspect you sleep quite well.
What about the shorter term aspects of gold. Let’s say you bought into an exchange traded fund back in June 2006 and you want to know what can you look forward to in the coming weeks and months? After all, depending on the day you purchased the fund, you probably haven’t made any money in your supposedly “secure” investment all while the Dow has posted numerous new all-time highs. I’ve put up a sixteen month day chart of gold below and it really is quite interesting:
There are several technical aspects that are worth noting here. The first one is that although gold is a long way up from the 542.27 lows of June 2006, gold is also a long way from being overbought. In short, gold has a lot of room to run to the upside. The next thing to note is that RSI, MACD, and the histogram all appear to be turning up as the price of gold has moved back above the 50-dma (667.39). This is good, very good. Now we come to a really important facet of gold, one that seems to escape a lot of investors, and that is gold has spent more than a year moving sideways. I contend that sideways action has allowed gold to build a huge base that will serve to drive the price of gold much higher than just about anyone thought imaginable. What makes the base so explosive is that we have a series of higher lows being compressed against an almost horizontal ceiling at 695.50.
Today gold remains range bound. The December gold futures contract has been stuck between 650.50 on the low side and 692.20 on the high side. The 692.20 is particularly significant as it represents a 50% retracement from the 608.80 low back up to the 775.60 all-time high. We have tested this resistance on five occasions this year and we’ve pulled back from it on five occasions. You may recall that oil did the same exact thing with what was significant resistance at 66.90. It finally went through it on the sixth try and it wasn’t long after that when oil posted a new all-time high. Gold is going to do the same thing. The December gold contract has five very important Fibonacci support/resistance levels and they are: 650.50, 672.30, 692.20, 711.80, and 733.90. Then there are five Fibonacci support/resistance levels of lesser importance at 671.90, 687.90, 685.90, 692.70, and 700.40. Notice that we have overlapping at 671.90/672.30 and again at 692.20/692.70 and that should add some significance. I now believe that we have moved out of the lower end of gold’s trading range (650.50 to 672.30) in preparation for an attack on the all-important 692.70 area. I believe gold will move through it this time and then attack the 711.80 resistance. Once safely above the psychologically important 700.00 mark, December gold should move quickly up to its May 11, 2006 high of 775.60.
Today gold remains range bound. The December gold futures contract has been stuck between 650.50 on the low side and 692.20 on the high side. The 692.20 is particularly significant as it represents a 50% retracement from the 608.80 low back up to the 775.60 all-time high. We have tested this resistance on five occasions this year and we’ve pulled back from it on five occasions. You may recall that oil did the same exact thing with what was significant resistance at 66.90. It finally went through it on the sixth try and it wasn’t long after that when oil posted a new all-time high. Gold is going to do the same thing. The December gold contract has five very important Fibonacci support/resistance levels and they are: 650.50, 672.30, 692.20, 711.80, and 733.90. Then there are five Fibonacci support/resistance levels of lesser importance at 671.90, 687.90, 685.90, 692.70, and 700.40. Notice that we have overlapping at 671.90/672.30 and again at 692.20/692.70 and that should add some significance. I now believe that we have moved out of the lower end of gold’s trading range (650.50 to 672.30) in preparation for an attack on the all-important 692.70 area. I believe gold will move through it this time and then attack the 711.80 resistance. Once safely above the psychologically important 700.00 mark, December gold should move quickly up to its May 11, 2006 high of 775.60.
And what about silver you might ask? While gold was catching a cold, silver caught pneumonia and damn near died. Looking at the same sixteen-month daily chart for silver shows that gold’s poor cousin really took a beating earlier this month.
You can see that the 50-dma is now below the 200-dma and we have a series of lower highs and lower lows. Then we see that MACD and the histogram are down while only the RSI is pointed in the right direction. Although silver became quite oversold, unlike gold, it is still a bearish picture. Like gold, the December silver also has its important Fibonacci numbers at 9.10, 10.16, 11.11, 12.07, and 13.12 while lesser sup-port/resistance can be found at 11.62, 12.24, 12.79, 13.34, and 13.95. In all honesty, I think silver is the cheapest thing out there and I have taken advantage of the recent massacre to load up on silver coins. I believe that every investor should buy a small quantity of coins every month regardless of price. Someday you will need them.
The real question in my mind involves gold stocks. I have been unsettled about gold stocks ever since the HUI appeared to follow the Dow more than the price of gold, but when I look at a chart of the HUI, I don’t get the same sensation:
Like gold we see a huge sideways movement with the same August massacre type affect we saw in silver. Now we have RSI, MACD, and the histogram all headed up and stocks quite oversold. On the other hand I believe the Dow will experience a severe decline before year’s end and I worry whether the HUI will be able to stand the pressure. If history is any indication, I suspect they’ll get caught in the downdraft. Unfortunately, my worries extend beyond the Dow and go to the heart of the industry itself. I see two major problems confronting gold miners and they are:
- A lot of small and medium sized companies were required to hedge their production in order to obtain financing. These hedges were written in such a way that, as the price of gold rises, the owners of these small and medium sized companies will be surprised to see they own less and less of their own company.
- Large miners are going to be subjected to longer and more violent labor disputes aggravated by governments that are increasingly moving left of center. That is especially the case in Latin America (just like 1930).
With respect to the second point, both unions and governments tend to view these companies as fat cash cows ripe for the milking. Without the workers, you can’t get the gold out of the ground and you can’t very well pick up your reserves and move if a leftist president comes knocking on your door. With all of this in mind, I am reducing my stock portfolio to 50% and I divide that 50% among four companies: Buenaventura (30%), Goldcorp (15%), Royal Gold (40%), and Volcan (15%). Notice how 40% of my new holdings will be in Royal Gold. This is a royalties company and therefore not subject to union problems or the normal risks that come with mining.
In conclusion, I think gold is going a lot higher. For a long time now gold has sold off the last week of each and every month without fail. This month may just be a different story as gold rallied hard on Friday and resisted offers to sell it off today. These changes in character usually precede major movements. I originally thought this leg would fizzle out at 775.00 (spot price) but now see gold topping out at 882.50 and may even trade as high as 1000.00! Why? It’s really quite simple. You don’t take sixteen months to build a huge base just to rally 20%. With that said, it will not all be smooth sailing. There will be a lot of volatility and I truly think that we will see at least one day where gold changes 75.00 in one session and it may even experience a triple-digit shift. Of course the airwaves will be filled with rumors and false innuendo. Central banks will threaten to sell all their gold in an effort to stop the rise and maintain the illusion that all is right with the world, but it won’t work. All is not right with the world and investors are going to find that out the hard way. My advice to you is to accumulate gold and silver on a monthly basis and just sit on it. Come back and look at the price in a couple of years and you’ll probably be glad you did.
More articles from this week's CompareShares newsletter:
Markets: Is the party over for the US?
Forums: The mysterious world of stock forums
Superannuation: Stay with super or convert to a pension?
Ask the expert: How to determine the best stock to trade
Politics: Forget the mud, it's about interest rates
Stock of the week: Mermaid Marine buoyant
Smart Investing: Risks of beating the market
Analyst report: Is sub-prime draining our resources?
Commodities: Gold hasn't lost its glitter
Whatever your views, you can discuss this article - or any of Enrico's articles - on our message board Your 2 Cents.
All views expressed in this article are those of the author, not those of CompareShares.com.au. Please seek advice relating to your personal circumstances before making any investment decisions. Enrico Orlandini runs Dow Theory Analysis - you can visit his website at http://www.dtanalysis.com/. Enrico is a well-regarded investment analyst who has written for a number of high-profile international publications, including Kitco.
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