Wednesday, October 15, 2008

Find me a bull market?

While the S&P, Dow, Nasdaq and Russell run around the playground and ride the see-saw, is there a place of refuge for the responsible to take advantage and earn some money? Over at HeadlineCharts there are four 28-year charts; one shows the past 25-year rally in bond prices, another illustrates the dramatic fall in the S&P, a third highlights the nascent rally in the dollar, while the last for the Commodity Research Bureau (CRB) displays recent fear but also a level of optimism and opportunity. Why?

In an US election piece at a case is made for the SPDR Gold Trust (GLD) assuming a McCain win. In a baby and bathwater situation we are presented with an opportunity not lost on the author:

I also continue to believe that we are still in the early stages of what will prove to be a multi-year boom for commodities, and much of the selling we have seen in gold appears to be primarily emotional reasons.

While the sentiment is correct, the vehicle of opportunity is not gold (yet!). But lets look at it in steps.

[1] The secular bull market in commodities is alive and well. What the commodity market is experiencing is a cyclical correction within a broader bull market. The stock market is also experiencing a cyclical move (not a correction) within the context of a secular bear market. While the picture of each decline is cringe worthy, the CRB index is only testing 2007 lows while the S&P is doing its best to test 2002 lows having surpassed all other support levels leading up to today.

[2] So why not gold? Three things make gold less attractive as an investment in the near term.

First, the dollar looks to have found some footing - even if this strength is only relative, i.e. other currencies are devaluing faster than the dollar. One only has to look at the ratio of the US dollar index to the Euro index to see it has moved off its 16-year low of 0.45 to its current value of 0.60 (it peaked at 1.43 in 2001).

The second reason against gold is its the only commodity to hold the bulk of its 2001 to 2008 gains; from a 2001 low of $255/oz it peaked at $1,033/oz in the early part of the year before falling back to the current price of $839/oz (18.8% loss from high / 229% gain from low). Silver, on the other hand, moved from a low of $4.01/oz in 2001 to a high of $21.44/oz and currently trades at $11.06 (48.8% loss from high / 175% gain from low). As an additional reference, oil is down 47.7% from its high of $147.90 and is currently testing its 200-week Moving Average (MA). Market bottoms only occur when everything sells off - at current valuations gold has yet to see the panic sell off which hit other commodities. Once gold sells off it will give the commodity market the ground work it needs to bottom. Gold Bugs will argue "This time is different" - as history shows, things are never different just the story changes.

The third reason to bet against gold is the behaviour of gold miner stocks. Is it any surprise to see Barrick Gold (ABX) 46% off its 52-week high? Compare it to silver miner Pan American Silver (PAAS) which is down 66% from its 52-week high. It appears investors in gold miners have already priced in a decline in gold prices. To make a simple ratio extrapolation; a 1% decline in silver equated to a 1.34% drop in PAAS. So based on the drop in ABX, gold could fall 34% (to about $682/oz). But this ignores the head-and-shoulder pattern in ABX which has a projected target of $19.11 (or a 65% drop from its 52-week high)

If the projected downward target for ABX was to hold true it could set an alternate target for gold of $531/oz (near 2006 lows). However, there is a positive side to this scenario and it's the 200-week MA. Oil prices are making an important test of its 200-week MA. Should oil succeed in holding this prior support level it would give optimism for gold to do likewise if such a test was made. Gold's 200-week MA currently trades at $649/oz - the last time Gold traded at this MA in early 2002 it broke though and kicked off the current gold bull market. The maths in this may be overly simplistic, but the perspective it provides is not.

[3] So when will it be gold?

At its simplest, when gold suffers the same way as other commodities have it will mark a bottom for all commodities. Other commodities have likely seen the worst of their losses, but until gold follows their lead they will continue to experience declines (which is why oil's test of its 200-week MA is important for the purposes of defining potential support). The global economy will eventually find its footing and industrial and energy commodity demand will slowly rise, influenced by the old and new economies of Europe, North and South America, China and India.

There is plenty of scare mongering and fear in the market, but history has shown these environments are opportunities to prosper, not panic. Emphasis is placed on time of buyers at peaks to breakeven, not on the returns made by those who took advantage of the fear to buy. Individuals who invested in 1932 would have made out like bandits by the time peak buyers broke even. However, early birds who saw the 1929 meltdown as an opportunity to buy would have suffered, given time (and inflation) would have made the 75% (or so) return to 1954 fairly meaningless.

It's for this reason we need to focus on the secular trend; not the secular bear market of stock markets, but the secular bull market of commodities. Gold looks destined to challenge $1,000 once more, but with a strengthening dollar it may fall under its own weight - if it does it will give a timing signal for a bottom. Whether this happens or not, remaining commodity prices are well off their highs and opportunities to bottom fish, industrial metals in particular, should reap dividends down the road.

We are six years into a 20-35 year secular commodity bull market - it's time to take advantage.

A list of commodity based ETFs for US and UK markets can be found here.

If there are readers interested in a copy of the annotated ABX Zignals stock chart with updated data please email me at

Dr. Declan Fallon, Senior Market Technician, the free stock alerts, market alerts, and stock charts website