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My Target for the XAU is 193

I will be at the Toronto Cambridge House Resource Investment Conference Oct 2-3. You'll find me at Dave Skarica's Addicted To Profits Booth so you can stop by and talk with me. Please, stop by. I'll also be speaking at his 3:00 PM workshop on Monday. For more information click here: http://www.cambridgehouse.ca/toronto/oct2005.html

People have been asking me where do I think gold stocks are going to go next year. Okay, I'm going to go out on a limb here.

I think the XAU is going to 193.

So how did I come up with such a specific number? It's simple, Elliot Wave Theory. Elliot Wave Theory was created by mathematician Ralph Nelson Elliot in the 1930's. His this theory compared the rhythm of the ocean waves to the price fluctuations of the stock market.

Two years before he died, in 1946, Elliott wrote his definitive work on his research entitled "Nature's Law - The Secret of the Universe". Elliott was convinced that his theory was a part of a much larger law governing all human activity.

In "Nature's Law", Elliott stated that the mathematical basis for the wave principle was a number sequence discovered (or more accurately rediscovered*) by the mathematician Leonardo Fibonacci who lived in the thirteenth century. In "Liber Abaci" (the best known of his three major works published) the Fibonacci sequence is first presented as a solution to a mathematical problem involving the reproduction rate of rabbits. The number sequence presented is:

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, ...

The sequence has a number of interesting properties. The two most noteworthy ones are first, each Fibonacci number is the sum of the two numbers preceding it, thus it is an additive sequence.

For example, 3 and 5 equals 8, 5 and 8 equals 13, 8 and 13 equals 21 etc; and second, the ratio of each Fibonacci number to its preceding number is alternately greater or smaller than the golden ratio. As the sequence continues, the ratio approaches the golden ratio, 1.6180339..., known also as "phi". For example: 144 / 89 = 1.617977, 233 / 144 = 1.618055 etc. The ratio of any number to its higher number approaches .618, after the first four numbers. For example, 144 / 233 = 0.618025 etc. Notice the values of 1.00 (1 / 1), .50 (1 / 2) and .67 (2 / 3) that area also important retracement levels.

Applying the Elliot Wave Theory to Financial Markets

There are three basic aspects of the Elliot Wave Theory - wave pattern, ratio and time (in that order of importance). Elliott claims that the Stock market follows a repetitive rhythm of a five-wave advance followed by a three-wave decline. The chart above shows one complete cycle. Wave one, three and five go with the main trend and are called impulsive waves. Wave two and four are corrective waves. After a five-wave advance has been completed, a three-wave correction begins, subdivided in an A-B-C structure. After that, a new five-wave advance can start.

Now what is interesting is that you can use the Elliot Wave theory to forecast the duration of market moves. I consider wave one the first phase of a bull market and wave two a consolidation period leading to wave three or phase two of the bull market.

According to Elliot Wave Theory, wave two retraces .618 of the move of wave one while wave three consists of 1.618 of wave one. Wave five is either 1.1418 or .382 of the total move of waves one through three.

Applying Elliot Wave Theory to Gold

So in getting back to the stock market, the XAU made a bottom in 2000 at 41.61. It then began wave one which ended in 2003 at XAU 113.41

According to Elliot Wave Theory, the XAU should have retraced up to .618 of the move from 41.61 to 113.41. Such a retracement would have brought the XAU down to 69.l376. The XAU made a wave two bottom at 76.79, which is pretty close.

Now we should be beginning wave three of the Elliot Wave sequence, which should add 1.618 times wave one points to the XAU. In other words wave three should add 116.18 points to the XAU (71.81 X 1.618). That would mean that wave three will end with the XAU at 192.97(116.18 + 76.79).

What is exciting for gold investors is that phase two of a bull market is the most profitable phase to be in. It is the longest and biggest cycle of a bull market. Wave three is also the most profitable wave in the Elliot Wave sequence.

At the moment, the XAU is consolidating below its key three year resistance level. The rally since May in gold stocks has been fun to be a part of, but the real move hasn't even begun yet. This consolidation period is the perfect time to either add on to your gold stock position or initiate one if you don't have one yet. We aren't quite at that time yet. The XAU appears to be consolidating below the 110-113 area just like it did below 95 back in June. We'll get an entry point soon.

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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