This is an exciting moment in time. I bought my first gold stock in February, 2002. Back then gold was trading in the $290 area and was below $300 an ounce. Everyone was talking about gold $300. Gold had been in a nasty bear market since the mid-nineties and $300 had acted as a critical resistance level.

Back then there were many well-respected analysts, such as Robert Prechter of Elliot Wave fame, who were calling for gold to pull back off of $300 and make new all-time lows.

Lots of gold investors had been so shaken up by the gold bear market and had seen so many false rallies over the years that they werent too optimistic either.

But gold did break $300. And when it did it managed to rise to $427 in less than two years for a return of 42%. Gold stocks went up even more with the XAU rising over 97% in that same time frame.

More Gains Expected in Wave 2

This was the first wave of a new secular bull market in gold. First waves are characterized by the so called "smart money" buying and fueling a rally. These are people who are very knowledgeable about a sector - the type of people who know that the fundamentals behind the sector are beginning to change for the better and realize that the stocks underlying the companies have reached low valuations.

Now gold is stuck below $425 an ounce - a number that is just as important as $300 was back in 2002. $425 represents a resistance level that has kept gold back for over 14 years. If gold decisively breaks $425 then it will enter wave two of its secular bull market. The next resistance level (really only a minor level) is $500, last seen in 1987. Gold could likely rally right through this point and go to the $550-$575 before another major correction would occur.

That would mean a possible run of 35% for the price of gold and another doubling for the XAU. What's great about 'wave two', which is typified by an acceptance of higher market prices by Wall Street and the beginning of an interest in the sector by the general public, is that it almost always lasts longer and brings higher price moves than 'wave one'.

Wave three is the final stage of a bull market and is marked by wide public interest in a sector, wild valuations, a widespread belief that the sector will always go up, and a manic type of investor psychology and behavior. Just think of the Internets in 1999. We are nowhere near that type of interest when it comes to gold.

Wave two of the gold bull market hasn't even started. We aren't above $425 yet. And just like in the first quarter of 2002 before gold broke out of $300 there are a lot of people now doubting that gold can break $425 and stay above that level.

Climbing a Wall of Worry

Gold investors have been shaken this year by a nasty correction in the first quarter and have seen gold pullback off of $425 several times already. Some experts are once again calling for a big gold collapse. Last month Morgan Stanley's chief commodity analyst, called for gold to fall to $375 before the end of 2004 and to drop down to $350 next year. Robin Wilkins, JP Morgan's foreign exchange and commodities technical analyst, says that, for now, gold "is in a choppy range with a slight near-term bias to the upside, but we'd be looking to sell into that strength."

Characteristic of the psychology surrounding gold right now is a Reuter's headline for a story about a September Denver miners conference, which reads: "Edgy gold investors to seek comfort at Denver show." The story went on to say that "gold stock investors are looking to company bosses to reassure them that their investments are safe."

That made me laugh.

In reality I have never been more excited about gold than I am now. I am convinced that gold is going to break $425 before the end of the year and begin the second wave of its bull market. I think most people are missing the big picture when it comes to gold. The current account deficit is widening, the US economy is slowing down, and the dollar is beginning to appear weak again. The technical gold picture is also getting more and more bullish.

Gold Vs. Gold Stocks

Gold stocks tend to lead the price of gold. It is usually bearish when gold stocks trade down or flat and the price of gold goes up. This happened when both made major tops in January. However, when gold stocks out perform the price of gold it is bullish. In the above chart I've circled the times when this has happened during this gold bull market.

As you can see as long as a pattern of the stocks out performing the metal continued both continued to rise. When this wasn't happening then both were either in a correction or were in a consolidation phase.

What is exciting is that since the middle of the summer the stocks have once again reestablished their leadership role and are out performing the metal. If this continues for the next several weeks then a major gold breakout will be all but assured.

On October 8 the price of gold hit $421.75 an ounce and the XAU hit a high of 105.07. Gold bounced off of this level and briefly fell below $408 while the XAU corrected 9%. Although both have since bounced, that move shook out a lot of bulls.

The XAU and the metal will have to spend the next few weeks or so recovering from this damage. I expect to see further sideways action and consolidation below gold $422-425 and XAU 105. The XAU is likely to stay stuck between 105 and 97 for the next 4-6 weeks, much like it did when it consolidated between 96.25 and 91 in August and September before it broke out in the middle of September.

However, if this next period of consolidation period ends in another rally that move up will likely bring the final defeat of the $425 gold resistance level and launch wave two of the gold bull market.

You need to watch one thing over the next few weeks - the relative strength of the XAU and gold. If the stocks continue to out perform the metal for the next few weeks then you must prepare yourself for the coming rally in gold.

What is amazing to me is that I get the feeling that everyone is asleep. When gold pulled back last week I did not see a single upgrade from a Wall Street analyst on a single mining stock. You want to buy the dips in bullish sectors when they have 5-10% pullbacks.

Once again it seems that investors are on their own. Right now reminds me so much of the first quarter of 2002. When we look back a year from now at the charts we may see that the next few weeks were the pivotal buying period, just as the first quarter of 2002 was the the final pause before the gold bull market began.

To find out what gold stocks Mike Swanson holds and plans on buying subscribe to his free Weekly Gold Report at http://wallstreetwindow.com/weeklygold.htm