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Buy Signal Approaching

As things stand today, the main threat for gold remains the anticipation that the Fed's next move will be an increase in interest rates. The markets currently expect that the Fed will make its first rate hike before the year end.

We believe the market is mistaken in anticipating that the worst for Wall Street is behind us and that the Fed is about to shift its priorities from preventing a recession to fighting inflation.

In reality, for politicians, central bankers and financial authorities, there is no question between the choice of price stability and the stability of the financial system. We are in the midst of a serious crisis of the financial system where the interests of all powerful players align.

Fixing the rusty Wall Street money-making engine and the suffering real estate market will take considerably more time than the market currently expects. Rectifying these two problems is on the highest priority list for Fed and the federal government. Inflation, while it cannot be ignored, is on a backburner. Obviously, the situation remains bullish for precious metals.

The most appropriate way to view the latest correction is as part of a continuing multi-month consolidation in precious metals. In fact, since March gold price is starting to form a giant cup and handle formation, which could propel its price to the next price target of $1,250.

We remain convinced that the final lows in this gold consolidation have now been set at around $850. But in terms of time, more consolidation work remains to be done. If gold holds $880 - $900 in August, this would be a very bullish sign going into fall and winter.

Yet it is important to remember that August often brings a seasonal low in gold and gold stocks. Trading volumes decline dramatically and little selling pressure can go a long way price-wise.

A sign that gold has finally found a bottom is a sharp recent rise in India's physical demand for the metal. Indians are typically fussy buyers preferring to buy at low prices and never to chase a rally.

Another positive sign is a long-awaited resilience of gold compared to crude oil. Despite many analysts' grave predictions of what would happen to gold when oil declined by $25 per barrel, the metal remained relatively strong falling by only 5.5% compared to 16% for oil.

In the meantime, while oil has further room to fall (first support at $120 and then $110), natural gas, which typically leads oil, may be very close to its low. Zinc, lead and platinum and some other metals may already have bottomed as well.

On the precious metals stocks, the main development is a buy signal issued by the Gold/$XAU ratio, which hit an exceptionally high level of 5.4. Over the past eight years, a reading between 5.0 and 5.2 triggered a reliable buy signal.

Gold bugs' sentiment collapsed last week. This is related to a painful washout in the junior sector combined with a serious correction among the senior producers.

A steep correction in $CDNX index (which represents small exploration and development companies traded on the Venture exchange in Canada), such as the one experienced in July, has typically produced a sharp rebound in the following months.

Our portfolio was hit by large losses in the past couple of weeks. As we have pointed out before, we are fortunate to have a sizable cash position which serves as a buffer against volatility. Many individual stocks that Resource Stock Guide tracks appear to be close to a bottom, after experiencing a similar meltdown as in August 2007. We continue to add shares of selective companies. Keep your buy orders on limit and considerably below market.

This is an excerpt from a Resource Stock Guide Newsletter dated July 27, 2008.

 

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