The Financial Commentator: Gold and Gold Stocks

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The Financial Commentator: Special Update
November 5, 2009

As promised in the October 18, 2009 letter, this is a Special Update for gold and the gold stocks.

As gold broke out of the triangle discussed in the August letter in early September, it made progressive new highs above the May 2009 peak in September, October, and now November. The gold stock indices also exceeded their May highs in September and in October. However, the gold indices are trading 6% below their October peaks, even as gold has pushed above $1,090. As gold was making new highs in September and October, the dollar made progressive new lows. With gold making a new high and assaulting $1,100, the dollar is holding 1% above its October low. This performance divergence between gold and the gold indexes and the dollar is at least a short term negative for gold and the gold stocks.

However, the intermediate term picture is also sporting an even more glaring divergence between gold and the gold stocks. When gold topped just over $1,000 in March 2008, the XAU was 209.27 and the HUI was 519.68. Gold is now 8% higher than its March 2008 peak, but the XAU is 170, or 18% lower, while the HUI is 17% lower at 430. In March 2008, the dollar was trading near 71.00, while it is trading just below 76.00 now. Given the negative sentiment toward the dollar, one would never guess it is up 7% from its multi-year low.

This performance divergence between gold and the gold indexes and the dollar suggests that gold is finally nearing an important intermediate top.

The gold indexes have retraced about 78.6% of their March 2008 to October 2008 decline (XAU 178.08, HUI 440.62), which looks like a B wave rally. Meanwhile gold has looks like an irregular B wave rally, since it rallied to new highs. If this pattern analysis is correct, both the gold stocks and gold are on the threshold of a large correction, possibly back to the 2008 October lows over the next year. Hard to believe. But with so much bullishness around in gold and the significant technical divergences, this is exactly the kind of environment that most tops are made, regardless of the market.

I would be surprised if gold doesn’t push above $1,100, at least temporarily. However, gold should not close above $1,115, so that will act as the stop for the following strategy, which is going to break the exposure into thirds.

DZZ – Buy 33% now ($15.20), 33% below $14.95, and 33% if it trades down to $14.65 – $14.35.
GLD – Short 33% now ($106.82), 33% above $107.50, and 33% if it trades up to $108.50 to $110.50.

Jim Welsh