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The Problem With Modern Monetary Theory

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Market Sentiment At Its Lowest In 10 Months

Market Sentiment At Its Lowest In 10 Months

Stocks sold off last week…

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Gold To Rally in 2005

No earnings rally. The DOW got smashed last week and we don't think we are at a bottom yet. We're close. But not close enough. We're on a buying watch though. Every day we are updating WSW Pro subscribers on whether or not we think the bottom is in.

Right now everyone is watching the DOW, but don't forget about gold. Unfortunately, there is a lot not to like about the way gold is acting right now. After having a nice run last Fall, the XAU gold stock index had a sharp correction between November and the first week of February, while gold fell down to 410.

After making an important bottom in February, the XAU rallied up to 104 and the price of gold almost hit 450 in the middle of March. Since then however it has been a tough story for gold bulls. The gold stocks started to once again lag the metal near the March high and the XAU has been falling ever since.

It is clear that gold and the gold stocks are undergoing a short-term correction. Some think that both will hold their February lows and form a double bottom that will lead to a huge rally later this year. Others fear that the February lows won't hold and gold will get totally smashed. Some think the gold bull market is over. CNBC no longer even talks about gold.

There are two troubling signs. First, the gold stocks are continuing to lag gold. This is bad, because the action in the stocks tends to lead the action in the metal. As long as the stocks continue to trend down quicker than gold, the downtrend will be in place.

Secondly, commercial futures traders remain heavily short in gold. They are very adept at timing the market. For the past four years, every time they have been heavily short gold the metal has dropped. They have also covered at major bottoms timing them correctly too. It doesn't pay to bet against them.

When gold hit 410 in February, commercial traders covered their positions. But as gold rallied back up towards 450 they piled on new short positions. What is troubling is that, even though gold has been dropping for the past four weeks, the commercial traders have barely covered at all. As of April 12, 2005, the commercials are 142,000 contracts net short. Bottoms haven't come until they have been net short much less, 40,000 - 75,000 contracts. It will likely take a drop in gold to at least the 400-410 to cause them to get their short positions to that lower level.

We are in a short-term downtrend and downtrends come to an end in one of two ways. Either they end in a final selling climax or in a slow base building sideways process. That would mean Gold would have to fall to 410 or even below it, with the XAU gapping down big one morning and then reversing on high volume to rally into the close. This is exactly how the gold bottom came a year ago in May. Downside for the XAU is probably 10% from here, with a fall of around 5% most likely.

A slow bottom would happen with the XAU trading in a 5-10%% range, say between 89 and 94, while the metal acts weak and falls to the 410-415 area. For this type of bottom to occur however, the XAU will need to reassert strength against the metal. The XAU will have to begin to outperform gold. This isn't happening at the moment and is the least likely scenario. But it could happen if the XAU is simply so oversold now that most of the sellers have been flushed out.

I am not sure exactly how gold is going to make its next bottom. I can't predict the exact price it will happen at. I just know what it needs to do in order to bottom and what it will look like when it comes. Whichever way it decides to bottom, it should do so within the next few weeks and I plan on buying more gold stocks when it does happen.

When that bottom comes, gold will be lined up to rally going to the end of the year. It is easy to get caught up in the negative emotions that are created by a correction. As long as the correction continues, more and more people will throw in the towel and give up on gold completely. That is what corrections do; shake out the weak hands.

But the fundamental story for gold is still very much intact. In fact, it is stronger than ever.

The trade deficit is still growing. The dollar is still in a bear market. What's more, gold has a seasonal tendency to rally in the Fall and into the end of the year. In the past two years, gold made important bottoms in the April/May time frame and then made yearly highs in December.

This dip in gold stocks and gold will end up being a buying opportunity. It should be the final bottom before gold rallies for the rest of the year. And it doesn't matter whether it happens as a double bottom, a slow base building bottom, or a final quick selling washout.

Keep your eye on the ball. I'll bet that the size and force of the next big gold rally will take a lot of people by surprise.

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.

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