Short-Term Rally?

This essay is based on the Premium Update posted on January 28th, 2011

January has been a tough month for gold. From its year-end 2010 price of $1,420 an ounce to its recent low just over $1,320, gold has lost some $100 – about seven percent. In percentage terms, this doesn’t amount to much of a correction in the metal’s 10-year- old bull market. Gold has corrected in price in excess of 20% no less than 46 times since the onset of the bull market in 2001. Each time, the market mavens heralded the bull market’s demise.

On Wednesday, the World Gold Council published its annual Gold Investment Digest for the fourth quarter and full-year 2010 with some interesting insights.

According to the World Gold Council last year’s price performance was driven by developments in key gold markets:

· China saw increased investment activity, driven in part by innovative new gold investment vehicles offering improved access to the gold market.
· Jewelry consumption rebounded in India, the world’s largest gold market.
· Globally, investors remained concerned about uncertainty in the macro-economic environment and turned to gold to hedge against weakness in the US dollar and rising inflation in many economies.

We find the last point particularly interesting, as the USD Index finished the year slightly higher than was the case in 2009. As mentioned many times in our updates, after 2006 things are much more complicated than simply USD up = gold down and vice-versa.
For the past two weeks we wrote about the risks that we might all face in 2011 and mentioned the problems caused by rising food prices and the social unrest they might unleash. We didn’t expect it to happen so soon.

After Tunisia’s revolution and the ouster of its president after 23 years of rule, Egypt seems to be next on the North African crisis list. One of the main grievances of the protesters in Egypt, just as it has been in Tunisia, has been the soaring price of food in the shops. The crisis and food shortages may spread to other Arab countries and no one knows where that can lead. We only know one thing—in times of crisis and uncertainty, people turn to gold for a safe haven.

To see what the near future has in store for precious metals let’s begin this week’s technical part with the analysis of the USD Index. We will start with the short-term chart (charts courtesy by http://stockcharts.com.)

In this week’s USD Index chart, a cyclical turning point is close at hand and should put an end to the recent declines seen in this index. It is important to note that the actual timing of the turning points here are somewhat delayed when compared to those of silver. Please note that silver did move higher on Wednesday – at its turning point, while the USD Index might have.

The sentiment for the USD Index is short-term bullish which also has bullish implications for gold, silver and mining stocks. Recall that during the past few months, the USD has been leading the precious metals and here could very well ignite a turnaround for the metals and the mining stocks. Perhaps we are already seeing this today.

Speaking of turning points, let’s take a look at the silver market.

In this week’s short-term chart, we see that once again a cyclical turning point has come into play. The small rally seen on Wednesday, though it only lasted for one day, could perhaps signal a new beginning and a subsequent rally. This would be very much in tune with price action seen around prior cyclical turning points.

That would be short-term bullish not only for silver but also for other parts of the precious metals market – including mining stocks.

The XAU Index of gold and silver mining stocks has moved to levels below highs seen in 2008. Verification of the recent breakdown has not yet been seen. There seems to be a strong possibility that the trend could reverse and index levels again move to or above these previous highs. Much depends on the verification of breakdowns and strength of support and resistance levels in other markets.

However, mining stock investments might be at risk in the medium-term. At this time, however, prices are below highs seen in 2008 and with an oversold situation prevailing today, a short-term uptrend appears probable.

Much appears to depend on how the situation develops in USD Index and the general stock market. The correlation matrix below provides us with details.

The correlation matrix shows that the medium-term coefficients are highest between gold and the S&P 500, as well as for silver and the S&P 500. In the short-term the metals – USD link appears valid and positive.

With the dollar approaching a cyclical turning point and likely to rally, gold, silver and mining stocks will likely follow. This week, this indirect relationship is visible also through our traditional measures above. Silver, of course, is also approaching its own turning point. The implications here are bullish for precious metals in the short-term, that is one to two weeks and bearish for the medium four to six week term.

Summing up, gold appears bullish in the short-term, however the sentiment for the medium-term is mixed. Much depends on how the resistance levels hold the next short-term rally. If they hold and stop the uptrend, then it may very well be prudent to exit a portion of one’s long-term positions. That is not the case today. The full version of today’s analysis includes detailed targets for gold and mining stocks – we encourage you to
read it right away.

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