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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Trading the Gold-Stock Bull 3

US$400 gold friends! Wow, can you believe it is really here? What a wonderful blessing! Praise God!

Our powerful new gold bull is not even three years old yet, but it already feels like a lifetime ago since we contrarians were struggling with the ultimate lows in the now deceased Great Bear in gold. Remember?

The Ancient Metal of Kings bottomed around $255 in early April 2001. At the time, very convincing theories about how gold was doomed to trade under $200 abounded. From many respected Elliot Wave counts calling for a final earth-shattering gold low to government worshippers claiming that unlimited central bank power would crush gold into powder, general negativity was ferocious at the bottom. And we are even talking about the generally pro-gold contrarian community here!

Outside of our maverick little world of contrarian thinkers, the mainstream thundering herd thought gold bulls were raving lunatics. Remember trying to talk with colleagues and friends about the huge opportunities in gold and commodities way back in early 2001? It was a frustrating exercise in utter futility. I suspect that someone infected with terminal Ebola Zaire dripping blood from their eyes and ears would have been more accepted at a cocktail party in 2001 than a gold bull!

Tech stocks were still the hottest game in town, even though the NASDAQ was trading down around 1800 even back then, a vast distance below its bubble top of only one year earlier. You had to have a skin as thick as a rhinoceros and a disposition to match to publicly admit that you were long gold and commodities during those dark days near The Bottom. We contrarians were the laughingstocks then.

Now, about 31 months later, gold is up almost 58% in its gold bull to date and the best gold stocks have achieved stupendous gains that even would have made a 1999 tech zealot green with envy. And the best part is that great commodities bulls in history tend to run a long time, often a decade or so at least, so odds are that our current gold bull is just a toddler now, with unlimited potential to blossom into a massive raging adult bull that few can even imagine today!

Ever since gold decisively broke $325 exactly one year ago to this very day, I have been mulling over some research work and essays on how high gold could go before this Great Bull ends. I can't wait to write them! The long-term future for gold and commodities-related investments is so bright right now that it defies attempts to put it into mere words. Fear not if you haven't yet been riding this bull for as long as us battle-hardened "old-timers" in when it began, as the ultimate long-term gains lying ahead still will almost certainly utterly dwarf those with which we have been blessed thus far!

But, even within powerful long-term secular trends, either bull or bear, there are always major countertrend moves that are quite tradable. This week's essay is not for you long-term buy-and-hold investors, bless your hearts, but for gunslinging speculators who are fortunate enough to have excess capital that can be used to actively bet on market fluctuations within primary trends.

Even if this Great Bull in gold has 10 years of running left, it will have episodes of strength and weakness, dizzying ascents to stellar new heights followed by normal healthy bull-market corrections to an ever-rising series of higher interim lows. For you fearless speculators not afraid of accepting big risks, this expected bull-market rhythm yields fantastic trading opportunities.

As it has been four exciting months since "Trading the Gold-Stock Bull 2" was published, I thought this week's amazing $400 achievements would be a great time to look at the short-term gold scene from the cold unemotional perspective of a short-term speculator. While no diligent contrarian, including you and I, doubts that gold is going way higher over the long-term, what about the next month or quarter?

First though, let's marvel at the amazing blessing of gold $400, a level that seemed impossibly high back in the dismal $250s days not so long ago! Please note that we zeroed both axes of this chart this week, to provide an important strategic perspective on the enormous relative gains of gold stocks compared to gold during our Great Gold Bull to date. The raw leverage of quality gold stocks to gold has been nothing short of astounding!

Gosh, can you believe it? This chart brings tears of joy to my eyes. Fighting the thundering herd as black-sheep contrarians is always very challenging and takes a lot out of anyone, but ultimate vindication and huge profits are such sweet victories that they instantly make all of the epic struggles along the way worth it. From the black hole of uncertainty when gold-stocks bottomed to the jubilation of the $325 Maginot Line falling, it has been one heck of a wild ride!

As is readily apparent above, gold stocks bottomed in November 2000, about 5 months ahead of the Ancient Metal of Kings itself. Since their respective brutal long-term bottoms, gold is up 58% or so but gold stocks have rocketed through the stratosphere. The increasingly popular HUI gold-stock index has achieved a breathtakingly massive 614% gain in three years while the venerable XAU is up about 168% over the same period of time.

Why the enormous difference in returns between these two elite gold-stock indices? Primarily the dirtiest word of the gold bull, hedging. The HUI is comprised exclusively of unhedged gold stocks while the XAU is dominated in market-capitalization terms by mega-hedging companies. The hedgers made the bad bet in recent years that gold prices would not rise or even fall, but they were terribly wrong and their shareholders have suffered tremendously for it.

On the bright side though, market discipline is finally exerting enough pressure on the notorious mega-hedgers to force them to change their injurious ways. Earlier this week I was fortunate enough to catch an interview with the CFO of Barrick Gold, the world's most infamous mega-hedger, on CNBC where he said that his company was committed to raising its stock price by decreasing hedging as rapidly as it prudently could. Hallelujah, even the mega-hedgers are finally seeing the light!

I kid you old-timers not who realize how odd this statement is coming from Barrick! I saw the interview with my own eyes though, and heard it with my own ears. Maria was even harassing the Barrick executive about hedging and how it had hurt Barrick shareholders, pointing out how greatly his competition like Newmont had been outperforming Barrick. I almost fell out of my chair in amazement! Will wonders never cease?

If you are interested in how all of the elite gold stocks of both the HUI and XAU stack up, you may wish to check out the new December issue of our Zeal Intelligence newsletter just published for our subscribers. In it I analyze every single stock in the HUI and XAU, which we put through a technical screen to check out their relative performances to gold and each other in every major gold rally to date in this awesome gold bull.

Among many fascinating revelations from our 12/03 ZI gold-stock study, the massive underperformance of the hedgers was instantly apparent in the technical screen. You can gain an idea of this in the graph above, where we labeled the huge and growing delta between the unhedged HUI and the hedger-dominated XAU as the "Hedge Tax". Shareholders in mega-hedgers have lost almost three-fourths of their potential gains by merely betting on the wrong gold horses since late 2000! Ouch.

While the long-term gold picture remains fantastically alluring, short-term cautionary signals are flashing that speculators ought to consider. For example, in the chart above, note the near vertical ascent of the blue HUI in recent weeks. Such sharp climactic moves often mark the euphoric interim tops capping major rallies within a secular bull. You can see the same phenomenon in mid-2001 and mid-2002, when vertical rises in earlier major rallies marked their interim tops and signaled coming normal healthy bull-market corrections.

Regarding these normal bull-market corrections to higher lows, the fractal nature of the markets is also quite fascinating. Fractals are an amazing branch of mathematics analyzing places in nature and industry where certain physical patterns tend to repeat at many different levels of magnification. In market terms, technical movements are often fractal in nature, with similar patterns visible on a daily chart, an annual chart, or even a decade-long price chart.

As any bull market runs higher, its latest highs tend to somewhat distort how major earlier moves appear visually. The mid-2001 vertical ascent of the HUI that ended its first major rally, for example, looks relatively tiny on the chart above. But, if you look at a chart from the time (third chart) the early 2001 rally looks remarkably like today's from a fractal geometry perspective. 2002's major gold-stock rally looks virtually identical as well (second chart). So, as speculators, the recent vertical blowoff in gold stocks alone ought to arouse our curiosity to dig deeper. So we shall!

Both of our own home-grown technical gold-speculation indicators at Zeal that I have discussed much this year, the Gold 50/200 MACD and the Relative HUI, are also forging into official neutral territory. As more and more technical indicators like these suggest that short-term caution is in order, the probability of a normal healthy bull-market pullback to higher lows in both gold and gold stocks grows.

If you scroll way back up to the first graph in this essay, you will note the white and black 50 and 200-day moving averages of gold intertwined with the metal itself. All that our Gold 50/200 MACD indicator does is mathematically quantify the interaction of the 50dma and 200dma of gold within constant terms for easy comparability. Specifically the Gold 50/200 MACD shows how far above the 200dma of gold its 50dma happens to be, at any time, in percentage terms.

Last time I wrote about this indicator in August, the HUI was trading around 175 or so and the Gold 50/200 MACD was still near buying territory. As this chart today shows, however, this key indicator has since crossed over into official neutral territory. This neutral signal actually flashed on October 21st, quite awhile ago but nevertheless an important initial sign that the interim topping process was probably getting underway. Naturally an Zeal Speculator Update was published for our alert-service subscribers when this signal went neutral.

Since the Gold 50/200 MACD broke 5% to the upside, our neutral signal, this indicator has soared to almost 7% while the HUI has rocketed vertically higher by 21% in matter of weeks. This behavior is really interesting as it mimics this indicator's precedent near the end of the enormous mid-2002 gold-stock rally shown above. Back then Gold 50/200 MACD neutrality flashed just as the HUI was about to enter its final vertical blowoff stage to a new bull-to-date interim high before a healthy correction.

Also provocative, note above how this indicator never tops until well after the major gold upleg it is marking ends and corrects. This is due to the inherent lagging nature of the moving averages, which trail actual prices considerably in reacting to short-term trend changes. While the Gold 50/200 MACD could certainly head higher, odds are that once it tops the interim top in gold and gold stocks will have already been officially carved some weeks earlier.

Trading this Gold 50/200 MACD neutrality signal is easy for speculators. All you have to do is stop deploying any new gold-stock positions once the 5% neutrality level is breached to the upside. You are going to have to be a contrarian with considerable discipline to pull this off however, as the short-term gold-stock euphoria is always deafening and ragingly bullish near these periodic short-term interim tops.

As far as your open gold-stock positions that you consider tradable speculations, you don't have to worry about selling outright when Gold 50/200 MACD neutrality is hit. In Great Bull markets like this one in gold, unforeseen major moves have the highest probability of exploding to the upside, so there is no sense in selling out any earlier than necessary since that temporarily ends your speculative upside exposure.

Instead, I just recommend that speculators raise their trailing stop losses when neutrality signals flash. Personally, I run my own stops at 20% trailing when I first buy a gold stock and then ratchet them up to 10% trailing or maybe even a little higher once these technical neutral signals flash. This grants me a good chance of catching any unforeseen upside breakout while at the same time limiting the risk to my unrealized profits when an inevitable pullback in gold stocks commences.

Naturally you can tailor your own stops to your own risk tolerance as well as the volatility and risk of your own individually chosen gold-stock speculations, but the important principle to realize is that stops should be raised when neutral signals flash. This is a cautionary preemptive step that forms a crucial foundational cornerstone of the prudent management of our scarce and valuable short-term speculative capital.

Although I use it as a gold-stock trading indicator, the Gold 50/200 MACD obviously keys off the primary moving averages of gold itself. A second tool specific to gold stocks alone is the Relative HUI. Discussed in depth in "Trading the Relative HUI", it compares the elite HUI unhedged gold-stock index with its own 200-day moving average.

Expressed as a constant ratio over time, it tells us how far above its 200dma the HUI happens to be trading. A Relative HUI reading of 1.50, for example, lets us know as speculators that the HUI is 1.5x its 200dma, or 50% higher. Interestingly, the Relative HUI just entered neutral territory itself in the past week, confirming the earlier cautionary signal flashed by the Gold 50/200 MACD.

On the shortened trading day after American Thanksgiving just one week ago, the Relative HUI officially broke into neutral territory closing at 1.51. It headed even higher earlier this week, closing at 1.55 on both Monday and Tuesday. While completely meaningless to long-term investors, to short-term speculators in gold stocks this is a key warning signal that our current gold rally, as awesome as it has been, is getting long in the tooth.

As you can see above, the most excellent major gold-stock rallies of 2001 and 2002 both gave up their ghosts not long after the Relative HUI crossed 1.50. The 2001 rally had a final blowoff spike to about 1.60 before correcting. The 2002 rally was much more powerful in the end, with an enormous yet brief final burst up above 1.80 before the inevitable bull-market correction to higher HUI lows arrived.

It is important to realize that our current rally could go either way here, failing soon near current Relative HUI levels or skyrocketing to one final blowoff high before retreating for a short season. As such, gold-stock speculators should play this Relative HUI neutrality the same way that we play Gold 50/200 MACD neutrality. We should start watching gold stocks very closely day-to-day, we should ratchet up our stops to at least 10% trailing or so, and we should get psychologically prepared to be stopped out if the markets move against us.

Once again raising stops on short-term gold-stock speculations instead of outright selling helps ensure that we have upside exposure in each major gold upleg for as long as is prudently possible. Upside breakout surprises to new bull-to-date highs, like the HUI has just gloriously carved, are far more probable in Great Bulls than unexpected downside failures. Thus, by raising our stops and staying long until the markets kick us out short-term, our probabilities of riding these major moves to near completion rise significantly.

Also, on a sidenote, I am raising our Relative HUI buy line from 1.00 to 1.05. After discussing this with my partners and some consulting clients, as well as analyzing a bunch of charts, a Relative HUI 1.05 felt like a more prudent moment to start watching to redeploy short-term speculative capital into gold stocks again. We don't want our buy signal so tight that we miss our moment, and as more folks out there learn about the gold-stock bull it is going to be harder and harder for the HUI to actually sink below its own 200dma at future post-pullback interim lows.

And this brings us to the bottom line. At first these indicators may seem confusing, but they are merely variations on a timeless fire-tested yet simple market theme. In any major trend, bull or bear, countertrend pullbacks to the 200dma of the primary long-term trend are expected and normal. Due to its very mathematical nature, the slow 200dma is the baseline off of which most long-term secular trends flow and ebb. Just look at the black lines in the charts above, or in any long-term strategic charts, and you will see exactly what I mean.

The time to deploy fresh capital is when a price is close to its own 200dma, and the time to protect that capital and get ready to be stopped out with realized profits is when the price is stretched far above its 200dma. Gold stocks today, love it or hate it, are far above their 200dmas. So is the Ancient Metal of Kings itself! The time to buy this rally was in late March/early April, when both gold and the HUI were near their 200dmas. That is when I bought and recommended that our subscribers and clients do the same.

If you missed this awesome 2003 gold rally, have no fear! There will probably be at least a half-dozen more major rallies of this magnitude before gold approaches a final mania bubble blowoff stage like in the late 1970s. Don't chase this rally today stretched far above the 200dmas, but instead prudently do your own due diligence now to get ready to deploy your speculative capital next time gold and gold stocks head back down to kiss their 200dmas. If history is a valid guide, this awesome opportunity ought to arrive in the first few months of 2004 or so.

If you are interested in what specific stocks we are thinking about buying the next time the gold and gold-stock prices converge to their 200dmas, you will be interested in the just-published December issue of Zeal Intelligence for our subscribers. Titled "Blue-Chip Golds", it analyzes all of the stocks in the HUI and XAU, looking at their relative performances in each major gold rally to date as well as their volatility and risk levels. A half-dozen winners emerged victorious, which I am looking forward to analyzing fundamentally in future issues of ZI.

As always, if you are a brand new Zeal Intelligence subscriber, we provide you with a complimentary electronic PDF copy of the current issue as our way of saying thanks for your business. I am very thankful for all of your wonderful support! Join us today!

While the long-term secular gold bull that now challenges $400 almost certainly has many years left to run yet, with the best gains lying ahead still, speculators still need to expect normal healthy short-term pullbacks to higher lows after major rallies. With gold stocks shooting vertical and both of our gold-stock indicators now neutral, speculators ought to prepare and gird themselves for just such a correction.

The coming short-term buying opportunities at the next 200dma convergences ought to be breathtaking, so please make sure that you prudently protect your short-term gold-stock speculative capital so that you can fully participate at the next major interim lows in gold and gold stocks. Godspeed!

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