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Oil and AMEX Gold BUGS Index Update

Note: The Elliott Wave count of the HUI (Figures 5 and 6) are at the end of the article.

Oil was initially first discovered in 1869 in Texas, The price continued to decline until it hit rock bottom just before 1929. The pattern to develop afterwards is clearly an impulsive pattern. Since peak oil is looming 2-4 years from now, the final leg of oil is upon us. It is important to take note that wave I and III lasted from 5-10 years. The spikes in oil were short and quick, followed by significant consolidations. The pattern is logarithmic, so the trend will continue. Wave III defined the bull market in commodities for the duration of the 1970's and wave IV defined the duration of the bull market in the stock market. The increase of waves I and III from the starting points of their base were 8.67x and 11.4x, respectively. The logarithmic advance also defines why the US went of the gold standard. As a country reaches peak maturity in its influence the currency must be allowed to inflate away. This appears to be the normal evolutionary process for a currency developing. Extrapolating from the continued advancement, wave V is likely to see a final oil price around $160/barrel or more in the coming 8-10 years (i.e. 2012-2014). The II-IV trend line is likely to be around $30-40/barrel, so when wave V tops out, the oil price will likely crash precipitously to around that level. What does that imply? This chart implies hyperinflation, followed by spike in oil to that level causing severe deflation. What will be best to hold at that point? Bullion and money in a safe currency. EVERYTHING and I do mean everything declines in value during deflation, but on a relative basis. If gold were to decline from $5000/ounce to $2500/ounce that is steep, but a house dropping from $300,000 to $30,000 or less is far more dramatic. This is one reason to accumulate bullion and simply hang on to it. Money made from stocks in the future can simply held to pick up real bargains when prices decline. Oil prices of $160/barrel will have a huge impact on slowing down the economies. Cash is usually king during deflations, but it must be in an accepted currency.

Figure 1

Chart courtesy of The Chart Store

AMEX Gold BUGS Index (HUI)

The upper Bollinger bands suggest a shallow correction is likely to occur during the next week or two, heading no lower than 230. A ribbon formation continues to develop with the lower Bollinger bands, which is positive, but notice the lower Bollinger band. It has a significant move ahead during the next 2-3 months so a stalling in the index should be expected. The full stochastics are still in a definitive up-trend, with a suggested 4-6 months left, unless a significant reversal occurred.

Figure 2

The moving averages are still in a bullish set-up (50-155-200), but the trend-defining 50 day MA is likely to move higher during the next two weeks while the HUI corrects slightly. Refer to Figure 5 for the Elliott Wave count of the HUI. It is a rather complicated pattern that has developed. Notice that during the six-month rise in 2003 the index rose while the short-term stochastics sported a longer-term negative divergence. The current rise in the HUI has somewhat of a parabolic base that formed. The %K is currently underneath the %D, suggestive weakness in the HUI should be expected for at least 5-10 trading days.

Figure 3

The weekly HUI is shown below. The lower 55 day MA Bollinger band (green) has nearly converged with the lower 34 MA BB. This implies longer-term strength in the HUI. Compression of Bollinger bands such as all lower coming in close proximity indicates the lower volatility patterns have based and a trend towards and higher prices until the upper BB's overshoot the index indicate a top. The full stochastics show the %K above the %D. Prior patterns in a similar formation suggest the HUI has 4-6 months remaining in the upward move. Purple trend lines were drawn for %K down trend lines. Whenever the %K broke above the downtrend lines, a vertical line was drawn upward until the index was touched. All three lines produced a rising purple trend line shown on the chart. The lower 55 MA BB always curled down with an accompanying move in the HU. As in prior instances, a very shallow decline is likely to be met with a strong advance.

Figure 4

The Elliott Wave count of the HUI is shown below. Figure 6 shows the past three weeks at a higher degree of resolution. The first leg up from late July until early October was wave (A).[X]. A corrective pattern has since been developing. Last week the pattern suggested wave [i].1.(C).[X} was underway, but the continuation of the corrective structure altered the count. The move up shown as [c].X is clearly an impulsive wave so it must be fit accordingly to the pattern. Wave X formed a flat pattern and wave Y is underway, with a formation of a diametric triangle. A diametric triangle can be either:

i) as witnessed here; a seven legged pattern with the first half being an expanding triangle up to wave [d] and the latter portion being a contracting triangle. This would be coined a "diamond". The pattern is not definitive of a diamond.

ii) A "bow-tie formation with an contracting triangle followed by and expanding triangle. Earlier long-term S&P charts make reference to a "bow-tie formation" early in the charts. The first half of the diamond is formed, and as the other charts suggest, weakness should be expected for the next 5-10 trading days before continuing the advance. A break below 230 would require a change in the pattern labeling. The green line shows the predicted path the HUI will follow during the next week or two. The worst case scenario is presented below. The index could go higher, but based upon the evidence in the wave structure, it is highly probable weakness will be seen this week minimally. The decline again to note will be minor.

Figure 5

The short-term Elliott Wave chart of the HUI is shown below. The definitive impulsive pattern is shown, followed by the thought "diamond pattern" forming. The index should have a crude degree of symmetry with the first portion of the pattern. The high degree of overlap in the wave structure makes it corrective. There is no other way to accurately quantify the wave behaviour based upon this observation.

Figure 6

Expect some of the froth in gold and gold stocks to diminish during the coming week or two as the next phase of the advance prepares to develop.

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