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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 4

The ongoing consolidation/correction in gold and gold stocks seems to be spawning a great deal of consternation amongst the contrarian community. Gold and gold stocks have been relentlessly grinding sideways to lower for a couple of months or so now.

The Ancient Metal of Kings itself carved its latest interim high around $426 in early January, and has been struggling ever since. The flagship HUI unhedged gold-stock index has not yet witnessed another new bull-to-date interim high since early December, when it closed near 257.

For those of you keeping score like I am, that was 11 long weeks ago since gold stocks assaulted fresh new territory on the upside! As always when the markets do not seem to behave and cooperate with a given worldview, a broad cornucopia of theories has bloomed to explain the recent dearth of progress in the gold and gold-stock worlds. Some of these theories are excellent, some are plausible, and others are just plain absurd.

As a mere mortal speculator with imperfect information, I do not know with 100% certainty why gold and gold stocks corrected. Maybe alien voodoo high priestesses living deep under the polar ice caps on Mars really did use an interplanetary mind-control ray to blast gold-market psychology negative. But maybe there is a far simpler explanation than some of these more outlandish correction theories!

Since we humans can never even hope to be all-knowing omniscient speculators, we have to deal in the realm of probability. Anything is always possible in the markets, but some things are less probable than others. For example, if I said that gold ought to trade $10 higher next week, you would have no problem accepting this idea since it is an event that has happened often in the past and has a high probability of occurring again.

But if I was to claim that gold ought to trade $10,000 higher next week, you would laugh. Why? You instinctively know from watching and trading the markets that a 25x gain in a single week on a global asset already approaching $2t in value is madness. Sure it could happen, but odds are that it never will!

In trying to understand why the gold markets corrected in recent months, we need to weigh all of the competing theories in terms of probability. The principle of Occam's Razor is very important in formulating market theories. We should not make any more assumptions than absolutely necessary and we should look for the least complicated and most simple explanation for the ongoing consolidation/correction in gold. The simplest explanation also has the highest probability of being the correct one.

So if we whip out Occam's famous razor and slice away all of the nonessential theories and variables on the gold correction, what are we left with? I believe that the simplest explanation is merely that gold and gold stocks were short-term overbought in recent months, and needed a breather before launching the next stage of their glorious bullish ascent!

It sounds trite, but markets go up and markets go down. Even within long-term primary secular trends, countertrend moves, such as a gold correction within a powerful gold bull market, are fairly common and ought to be expected periodically. Indeed, this current correction in gold was expected. I have written about it extensively and my clients and subscribers were ready and waiting for it in advance.

This week I would like to review and update the key technical charts that alerted my team and me that a gold and gold-stock correction was expected and coming. I have been warning of this in our monthly Zeal Intelligence newsletter, our anytime Zeal Speculator alert service, and in these weekly Web essays. Where appropriate, I will quote from these earlier dispatches so you can see for yourself how this correction was certainly no surprise to vigilant gold and gold-stock speculators.

Even more importantly, however, these very same charts will help us to discern the golden opportunity when the gold and gold-stock consolidation/correction is nearing its end. These are among many indicators that we have painstakingly developed and continue to watch that will help alert us and our subscribers to the ideal moment to deploy heavily long again to ride the next massive upleg in gold and gold stocks.

After you review these charts, I hope that you will have a deeper understanding about how there are both high-success-probability and low-success-probability moments in time to go long a secular gold bull in terms of short-term speculations. Our goal continues to be to only trade during the high-success-probability opportunities while we patiently sit out the low-success-probability times.

Our first chart this week shows Relative Gold, or the price of gold divided by its 200-day moving average. It illustrates just how far above its key 200dma that gold happens to be trading at any given moment, in perfectly comparable constant-percentage terms. A reading of 1.10, for instance, indicates that gold is trading at 1.1x its 200dma, or 10% above this key technical level.

In any major long-term secular bull or bear market, short-term countertrend moves are natural and inevitable. The long-term 200-day moving average is the almost magnetic line that many of these short-term countertrend moves tend to seek out before they reverse. On almost any price chart of any market from any era, you will see Great Bull and Great Bear trends continually extend away from and then periodically retreat back to their own all-important 200dmas.

In our young bull market in gold to date, which launched in early 2001, gold has approached, kissed, or momentarily breached its key 200dma support a half-dozen times. But, since this is a powerful bull market based on a long-term global supply and demand deficit of physical gold, the primary trend remains pointed towards the heavens. As such, each countertrend 200dma correction in gold was short-lived and heralded the advent of another glorious vault higher.

While most folks have no problem understanding the great logic of buying near 200dma approaches, it continues to amaze me how many people choose to brazenly ignore the obvious corollary. When gold gets extended too far above its 200dma, it is simply short-term overbought and a short-term correction is due. We don't need to worry about Martian voodoo priestesses when Occam's Razor can slice away all of that nonsense and leave us with the normal ebb and flow of a secular bull market.

If you look at the blue gold line relative to the black gold 200dma line above, you can generally see when gold is close to or far from its most important long-term support line. As the bull market progresses, however, this visual comparison rapidly becomes skewed. Earlier days appear to be tiny visually while recent months dominate a chart. We developed Relative Gold to address this limitation, to provide a perfectly comparable constant-percentage reading of the distance that gold happens to be from its key 200dma.

The red line above mathematically quantifies Relative Gold through time. In our fabulous bull market in gold to date, gold has tended to oscillate between just under 1.02x its 200dma to just over 1.11x its 200dma. Now if you examine this chart carefully, you can see that this Relative Gold line helps speculators determine when high-success-probability opportunities to buy or sell gold happen to exist.

On the low side, any time that Relative Gold trades under 1.02 or so, the green buy line rendered above, speculators have been blessed with a fantastic opportunity to deploy short-term gold-related speculations on the long side. In addition, these very same moments are the ideal time for long-term gold investors to increase their own positions when they wish to feed fresh capital into the ongoing gold bull. Buy low!

As the chart above clearly shows, every single time that gold has traded within 2% of its 200dma a major gold upleg has ensued shortly after. Mid and late 2001, late 2002, early and mid 2003, they all marked ideal moments to throw aggressively long and prepare for the next major upleg in gold. So, next time Relative Gold trades under 1.02, get ready to buy any new positions that you want to deploy, regardless of if you are a speculator or investor.

Even within a primary bull though, major uplegs are finite and are inevitably followed by corrections. As the chart above shows, once Relative Gold breaks 1.11 or so to the upside it is time to go neutral, as odds are that the current gold upleg is finally drawing to an end. In our bull to date every single time that gold has traded more than 11% above its key 200dma marked short-term topping periods prior to significant consolidations and corrections.

I don't call Relative Gold 1.11 a sell signal though, just a neutral. The reason is that in a primary bull market the probability of a massive unexpected upside breakout always exists. There is no sense in liquidating long speculation positions any sooner than the markets force us to!

If you are a long-term investor and see a Relative Gold reading above 1.11, you can just ignore it. But if you are a short-term speculator you ought to considerably tighten up your trailing stop losses on gold positions in anticipation of a coming interim top and short-term correction once Relative Gold 1.11 is exceeded. If the markets correct aggressively enough, you are simply stopped out of your open positions with awesome realized profits. Piece of cake!

Now applying this sound trading theory to real life, Relative Gold broke 1.11 to the upside on December 1st, a crystal-clear signal for speculators to prepare for an interim top and ratchet up their trailing stops. If anyone tells you that this correction was unanticipated, they are not telling the truth. On December 5th in my "Trading the Gold-Stock Bull 3" essay I wrote&

"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."

Remember Occam's Razor? No complicated theories were necessary to anticipate this ongoing consolidation/correction. Simple technical market rhythms were completely adequate to protect yourself from this predictable short-term gold weakness. Gold was overbought, a correction was due, and here it is. No big deal. And there is no rocket science or Martians necessary!

These periodic 200dma-convergence countertrend moves happen in both bull and bear markets alike. Since gold is the ultimate form of money, the dollar gold price is essentially the exchange rate between mighty gold and the fragile fiat-paper US dollar. As such, any short-term dollar strength within the dollar's secular bear will often translate into short-term weakness in gold in dollar terms. Comparing the Relative Dollar to Relative Gold can warn us of potential approaching bear-market rallies in the US dollar.

This second chart shows the exact same Relative Gold line rendered in the first chart above, although it is colored in blue this time. The second red line here is the Relative Dollar, the US Dollar Index divided by its key 200-day moving average. Since the dollar is in a secular bear market, it is usually trading below its 200dma so its Relativity reading is generally less than 1.00 these days.

The interesting thing that we were watching in early January when I first wrote about this chart was the nearly 0.90 Relative Dollar reading at the time. The dollar had bounced near 0.90 and entered major bear-market rallies in each of the previous years, so 0.90 looked like a potentially dangerous level for gold this time around too. Any dollar bear-market rally would lead to a lower US dollar/gold exchange rate, or gold price, over the short-term.

In recent years each time that the US Dollar Index entered a countertrend bear-market rally back up towards its overhead 200dma, gold fell right along with it. You can see this in the chart easily in Relative Gold terms. When a dollar bear-market rally kicked off, gold retreated from levels high above its own 200dma back down to levels right near its 200dma. As such, a low Relative Dollar coupled with a high Relative Gold was another crystal-clear technical warning signal for speculators.

On January 9th, incidentally the very day that gold carved its latest interim top, I discussed the first iteration of this chart in my essay on "The Relative Dollar and Gold". It heralded a coming consolidation or correction in gold so that is what I wrote about. And, believe me, it is no fun at all writing about gold pullbacks when new bull-to-date highs are being achieved, as an analyst is instantly vilified by thin-skinned gold investors who feel threatened when anyone dares suggest that gold is not going to rise by 10% a day for the rest of eternity.

I closed that essay with, "For now though, the oversold dollar levels and overbought gold levels in Relativity terms are troubling. The US Dollar Index really looks like a major countertrend rally is imminent and due. And if a bear-market rally in the dollar launches, for any reason, odds are that gold is going to get hit over the short-term. Get ready!"

Why was I concerned on January 9th as gold carved an interim top? Not because I believed in Martian voodoo priestesses and mind-control rays, but simply because the markets ebb and flow and the dollar was about due for some short-term flowing strength. Why even consider complex and inherently unprovable theories on the gold correction when a simple and anticipated technical market rhythm can easily explain these things?

For speculators, the best time to throw long gold in anticipation of a major upleg is when both Relative Gold and the Relative Dollar converge near 1.00 or so. Just as a Relative Dollar level approaching 1.00 heralds the end of a major bear-market rally in the US dollar, the Relative Gold level near 1.00 that we discussed above marks the end of a major gold correction. It pays big to stay abreast of these important technical developments if you are a speculator!

Gold stocks have been weaker for over five weeks longer than gold itself now. Just as the correction in gold was natural, normal, and fully expected by vigilant speculators, so was the correction in gold stocks. Our final chart this week showcases the HUI and Relative HUI, computed using the same simple methodology discussed above. Just as we witnessed in gold, the HUI also advances far above and then corrects back down to its key 200dma periodically. All markets rise and fall, ebb and flow.

Just like gold or any trending market, the HUI also oscillates between conservative levels near its 200dma and extreme levels far above its 200dma. In Relative HUI terms, we have been using the range of 1.05 to 1.50 for general gold-stock speculation signals. When the HUI crosses under 1.05 speculators should consider aggressively throwing long gold stocks, and when it exceeds 1.50 they ought to consider raising their trailing stop losses in anticipation of a correction.

Indeed, every single time that the HUI traded under 1.05 in the chart above it has preceded a major upleg in gold stocks. If you are looking for high-success-probability moments to either deploy fresh long short-term gold-stock speculations or add to your existing long-term gold-stock investments, it is hard to beat an opportune moment when the HUI corrects back down to within 5% of its key 200dma.

On the other hand, contrary to the deep faith held by the fervent gold-stocks-to-the-moon-today zealots, gold stocks, just like every other bull market in history, move both up and down. Yes, the general long-term secular trend is gloriously higher and will be for a long time with such awesome fundamentals, but short-term consolidations and corrections are healthy, natural, and normal.

Either fearing or becoming irritated by a short-term gold-stock correction is as completely irrational as getting upset that every sunrise is followed 12 hours later or so by a sunset. Markets, prices, and general emotions ebb and flow, moving up and down in endless cycles. Trading with the long-term trends like the gold-stock bull is very wise, but growing upset at short-term deviations from these long-term trends is a total and complete waste of time, a telltale mark of speculator immaturity.

The HUI, like any bull market, can become overbought over the short-term and in need of a healthy correction. As the Relative HUI 1.50 neutral line above illustrates, every single time in this bull market to date that this level has been exceeded a correction and/or consolidation closely followed. Anytime the HUI is trading more than 50% above its 200dma, extreme caution should be exercised by gold-stock speculators as odds are that a short-term interim top preceding a major pullback is near.

In current terms, the Relative HUI broke above 1.50 this time around on November 28th. Two days after the HUI carved its latest interim top on December 2nd, I warned our Zeal Speculator alert-service subscribers about the imminent pullback. On December 4th I wrote, "Nevertheless, stops are very important here since the gold stocks are so short-term overbought at these levels. Please watch your gold-related speculations and be ready to get out if your stops are hit or prices fall rapidly."

Dear friends, this gold-stock consolidation/correction was fully anticipated by vigilant speculators! There was no need of magic or complex theories either, as the Occam's Razor of crystal-clear technical developments highlighted this growing short-term risk on the long side of gold stocks. There is no reason that this correction should have surprised anyone.

On the bright side, as this HUI chart illustrates, the Relative HUI is already bleeding off the speculative excesses of late November and early December rather nicely. The HUI has still not retreated close enough to its key 200dma to enter the high-success-probability strong-buy zone under 1.05 yet, but it is getting relentlessly closer and will probably be hit in the coming weeks or maybe months on the outside.

Naturally we will continue tracking all of these indicators that we have developed, and more, in our acclaimed monthly Zeal Intelligence and anytime Zeal Speculator newsletters for our subscribers. When the time comes to throw aggressively long again, we have already researched the most promising gold-stock picks to buy for the next major gold upleg, which I discussed in depth in recent issues of Zeal Intelligence.

I am ready and eager to recommend each stock specifically and buy them once we see the telltale technical signatures suggesting that this short-term gold consolidation/correction is drawing to an end. Please consider honoring us with your subscription today if you want to know when this coming fantastic buying opportunity has arrived! We are committed to only launching major trades when the probabilities of success swing wildly in our favor!

To wrap up this fourth installment of my essays on trading gold stocks, it is crucial to realize that the current gold and gold-stock weakness was not random but was anticipated on the record in advance.

As a speculator you can choose to believe crazy theories about this development, choose to waste your energy by getting angry and arbitrarily assigning blame to someone else for this correction, or you can just accept it and live with it. I choose the latter.

I do not care at all why this correction is happening. Who cares and so what? It is not relevant. But I do care about attempting to only buy low by not getting caught up in the incessant hype and maniacal rantings surrounding recent gold developments.

The simplest and cleanest Occam's Razor explanation for these events was that gold and gold stocks were merely short-term overbought and needed to blow off some speculative steam. Odds are that Martian voodoo priestesses had nothing to do with it!

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