Gold about to Show True Colors

There is a saying that "old generals fight old wars." This saying applies to most analysts' erroneous grasp of the gold market. Most of them are fighting the "old war" of inflation, expecting any rise in the price of gold to be a consequence of an inflationary flare-up in the physical economy. What they fail to grasp is that today's market environment is much different than that of 20 years ago—the last time gold experienced a major bull market. At that time, gold's phenomenal rise in price was a measure of the inflated value of the dollar, hence inflation. But that was at the other end of the K-Wave, specifically, the top of K-Wave inflation. Today, 20 years later, we are near the bottom of K-Wave deflation, which means that the rules of 20 years ago no longer apply to today's market. At both ends of the K-Wave—inflation and deflation—gold performs extraordinarily well, but especially in late runaway K-Wave deflation (2001-2009). But with general deflationary conditions prevailing, how is this possible?

Simply because in late runaway inflation gold's value is a measure of general dollar weakness, while in late runaway deflation gold's value is a general flight to safety in the fact of collapsing debt structures worldwide. Gold always shines brightest in the late stages of deflation since its inherent value as the ultimate financial safety mechanism and store of wealth comes to the fore. In such times, gold becomes the unanimous investment choice by default. The coming years will witness such a flight into gold that—barring any government intervention (a la' 1933)—will propel its price to levels unseen in decades, and possibly to new all-time highs. The important thing to keep in mind is that the old relationship between gold and the dollar does not apply in the late stages of the K-Wave, as it did in the earlier stages.

Proof that the gold is already starting to disconnect from the dollar is the action of the past week. During this time, the dollar showed strength relative to most major world currencies while gold, instead of declining in dollar value, rose in price. Trading volume on the COMEX has picked up nicely in recent days. In fact, volume alone yields several important clues that gold is about to begin its rise. For one, volume saw a noticeable contraction in recent weeks—drying up almost completely at one point before bouncing back strongly on gold's recent rise in price. This is a sign that the sellers have completed their liquidation and the insiders have completed their accumulation campaign, or nearly so. In prolonged accumulation campaigns like the one in gold in recent years, insiders buy up the existing supply by merely sitting back and waiting for the weak hands to liquidate their holdings. They do not actively bid on prices, they merely absorb whatever supply comes onto the market. This is what creates the dull, narrow bottoming pattern on the chart. If the buyers were very active in their campaign, it would have the result of attracting too much outside attention, which is what they try to avoid. Insiders quietly accumulate for the express purpose of starting a well-publicized bull market so they can sell their holdings to the public as prices are rising. Then, when their line is all sold out, a reaction sets in and they can buy from the public once more on the way down and begin another bull campaign.

The financial press is typically an accomplice to insider accumulation and distribution campaigns. This has been the case where gold is concerned. In the past few years we have witnessed a steady stream of propaganda from the mainstream media to the effect that gold is a "barbarous relic" and is "dead in the water," all of which is quite laughable when one considers that gold is still—even in these supposedly "enlightened" times—the most actively traded market on earth. Someone obviously doesn't share the opinion of the opinion makers.

Nevertheless, this anti-gold rhetoric has served its use, since the public largely avoids the gold market, enabling the insiders to buy up as much of the floating supply as they like. When it comes time for the bull campaign to begin, rest assured the financial press will once again be called to aid the insiders, this time to loudly report how gold is gloriously rising to vertiginous heights with no limit in sight. This will create the band-wagon effect and will propel gold's price even further. When once the first correction sets in, the insiders will step in and repeat their tactics until finally the market has been completely exhausted and a bear market must begin. This is the pattern that has been repeated for centuries in every market. Nothing ever changes in the marketplace.

Undoubtedly, gold prices have been unnaturally suppressed throughout the better part of this seven-year accumulation campaign. One thing we have observed in years of chart reading is that whenever a security is beaten down beyond the natural course of the cycles, when once that security rises again it always does so with a vengeance, as a way of compensating for being over-sold. This is a concept developed by the great cycle expert W.D. Gann and summarized in his theory of "balancing of time and price." He noted that markets always compensate for extreme movements in one direction or the other. Since gold has been extremely depressed/suppressed for these many years, one can only surmise that it must overbalance this extreme by moving strongly in the opposite direction with respect to price and time.

Cyclically and seasonally, gold is due a nice impulsive move to the upside right now. In fact, it appears this long-awaited move has begun based on a reading of gold's market action these past couple of days. We have already noted that gold's volume patterns confirm our bullish take on this market. Open interest is also supportive of this since it has been pointing in favor of a net long position in gold among the commercials and insiders. From a short-term perspective, gold has displayed a pronounced five-month cycle stretching back several years. For instance, in 1998, gold saw a seasonal low in March of $287.30 followed by another low at $273.80 five months later. Five months following this gold saw a high of $285 in January, followed by alow of $253.90 in July five months later. In December 1999 gold topped at $280.30 and declined to $270.70 five months later in May. Five months from there brings us to the present in October and the low of $272.90. We should see rising action in the gold market for the remainder of the year. Larger cycles, such as the 140-week cycle, are also in favor of a sustained upside move in gold.

Perhaps the most useful technical tool for isolating cycles in any given security is the rate of change (ROC), or "momentum" oscillator. By constructing a 144-day ROC oscillator for gold futures, which timeframe has a Fibonacci as well as a cyclical significance, we found that gold has already seen its major bottom and is now in the early ascending phase of its intermediate-term cycle. The indicator is coiling around the point of equilibrium, which implies a huge breakout is approaching. Unquestionably, that breakout will be to the upside.

When we survey gold's daily chart for the past year one very conspicuous pattern stands out—that of a bowl-shaped curve, which always represents accumulation. This same pattern is apparent in the XAU and several leading gold stocks, like Barrick and Placer Dome. Often, when the insiders who are conducting the buying campaigns that produce these bowls are attracting too much suspicion, they will allow a temporary break in the bottom of the bowl to occur, thereby giving the appearance of the beginning of a major sell-off. In reality, however, this was merely an artificial move designed to shake out the weak hands and scare away the public from buying into the early stages of the bull campaign. This is precisely what happened in the XAU last week, but we note the recovery was quick. From here, prices should begin rising as the first leg of accumulation appears complete.

The approximate time length and amplitude of gold's approaching rally can be calculated in advance by adding up the number of contracts traded during the time of its bowl formation (which began last fall). When gold begins its sustained rise approximately the same amount of volume must be dissipated before the first substantial reaction can set in. This is why last October's big move in gold only lasted a few days—because accumulation up to that time wasn't pronounced and all the volume was used up in pushing prices up to the $340 level. This time we expect a far longer and more sustained rise as the accumulation period has been much longer.

The outlook for the mining stocks is still bullish, notwithstanding recent appearances of weakness in certain blue chip golds. Last week's low in the XAU does not change our intermediate- and long-term bullish stance on gold. It may signify the beginning of a short-term sell-off in gold and mining shares, but nothing that will undermine gold's technically sound position. In fact, gold mining shares will likely prove to be among the few counter-cyclical stocks sectors of the depression ahead. Every bear market has its counter-cyclicals, and just as gold stocks bucked the general trend during the last Great Depression they will probably do so this time around as well.

We remain firmly convinced that gold has been under accumulation for some time now. In fact, it has been in the process of bottoming for over seven years. The very fact that there is a bowl pattern at all indicates strong accumulation. By 2001 we fully expect gold prices to be considerably above the level at which they now remain.