Making Sense of This Gold Drop - Mike Swanson (10/04/07)
by Mike Swanson on Thu, 2007-10-04 10:36.
Yesterday the XAU dropped 2.06 points while the HUI fell 5.75. Both fell much harderthan gold on a percentage basis. We've seen a huge rally in gold stocks in the past fewweeks - one that on a long-term chart appears to be a key turning point as the gold marketappears to have ended its lengthy seventeen month long period of consolidation and isbeginning a new bull run. However, at the moment it is setup for a period of consolidationfor the next 2-3 weeks before it moves higher. I'm going to be looking to add on to mygold position during this time frame. If past history holds than the 153-156 area will bekey support for the XAU.
The XAU and HUI both rallied above their 200-day bollinger bands, which tends to act aslong-term support and resistance during periods of consolidation in the gold market likewe have seen in the past year. Once a market breaks above its upper 200-day bollinger bandand enters a bull run it usually pauses or has a quick pullback before going higher. Eachof the past three times the gold market has done this in the past six years it has pulledback before going higher. I have circled these areas in the above chart and examine thembelow.
During 2002 the XAU broke above its 200-day bollinger band and then traded back below it.It then broke out a second time and pulled back before moving higher. The first pullbackwas a 14% correction and the second was a 9.3% correction. The first breakout was a fakeout and the second the real deal. The same pattern seems to be true now. We saw the XAUand HUI move above its upper 200-day bollinger band in July and then collapse. This secondbreakout in September appears to be the real move.
The breakout in 2003 was a bit different than the other two moves and current one as thetime spent between the upper and lower 200-day bollinger bands before the breakout was ofmuch shorter direction. Consequently the bull run was the shortest, lasting only ninemonths from the bottom to the top. As a general rule the longer the period ofconsolidation the greater the price gains of the subsequent bull run and the longer itlasts.
The move in 2005 is similar to the current one as gold stocks collapsed right before therally began. They then rallied 50% off of their May 2005 lows and peaked above the 200-daybollinger band. The XAU then corrected 12.4% and moved higher. Something similar is likelyto happen now as the XAU rallied roughly 40% from its August low to its September peak.
There are some key lessons to learn from the past:
1)Each time the XAU and HUI for that matter started new bull runs they did so bybreaking above their 200-day bollinger bands after at least 8 months of consolidation inwhich the 200-day bollinger bands narrowed. The length of each bull run was related to thelength of time spent consolidating beforehand. The longer the period of consolidation thenarrower the 200-day bollinger bands became before the next bull run began and the longerthe next bull lasted. This is the narrowest the 200-day bollinger bands have ever been andtherefore this next bull run in gold stocks should be longer than any of the previousthree.
2)Everytime the XAU began its bull run after its breakout above its 200-day bollingerband it quickly corrected. Past corrections were between 11% and 14%.
3)These corrections all ended near the XAU's 10-day bollinger band, 50-day movingaverage, or upper 200-day bollinger band.
4)Once the short-term correction ended the XAU spent up to another week consolidatingin a very narrow range, which caused the 10-day bollinger bands to almost pinch thecandlestick price plot of the XA and led to another blastoff in gold stocks. My plan is tobuy if we dip and I think the correction is over and then add on once the XAU's 10-daybollinger bands narrow. I will also be tracking the HUI and GDX for buy signals.
If the XAU corrects from here support is at the following levels:
1 - 160 - the point of the XAU's upper 200-day bollinger band.
2 - 153 - the 1/3 retracement level of the XAU's August low and September peak. Thiswould be a 11.5% correction off of its highs and equivalent to 357.77 on the HUI.
I consider the 153-158 area as solid support for the XAU and a buy zone. Duringshort-term corrections in gold stocks the stocks tend to underperform gold for a veryshort period of time as they are doing at the moment. Once they start to hold up againstthe metal declining the correction is usually soon over. If this were to start to occurbelow the 160 level on the XAU I would use this a sign that we are near a bottom, and itis time to start to average in and build or add on to a position.
Past history suggests we will see a correction in the XAU over the next 5-10 tradingsessions that brings a fantastic buying opportunity. I will use it to buy more goldstocks. It is possible that this time is different and we don't get as big of a correctionas we did in the past. If this is the case than I'd expect the XAU to continue toconsolidate for the next 5-8 days, with support at around 160, before it breaks out.Either way I expect to be buying more within the next two weeks.
I expect the next leg up in the XAU and HUI to be at least a 30% move higher from itscurrent levels. It would then likely have a correction before moving higher again. If youaren't in gold stocks or want to add on next week is going to give you an incredibleopportunity that you can't pass up. I've just recounted how the XAU has corrected in thepast when it has rallied like it has and started a new bull run. What comes after thisrally is returns in excess over 50% in just a few months.
For daily comments from Mike and a list of stocks that he believes will lead the nextbig rally in gold stocks take a subscription to his WSW Power Investor service. Just
About Mike Swanson
Mike Swanson is the founder of WallStreetWindow. Through the premiumWallStreetWindow Power Investor Service he provides daily market commentary and tracks atop ten list of stocks that he believes will outpeform the stock market and generate tenbag type returns. Take a 30-day risk-free trial to WSW Power Investor now. Would you liketo buy a stock right now that you can put a fifty cents stop on and have a chance to makeforty fold that? Click here.
