How to Handle the Gold Stock Correction...

There are two important factors indicating that the Precious Metals sector is at a near-term top and that a significant correction is beginning, or will soon.

The 1st factor is that many gold stocks have become seriously overbought over the past few weeks and very extended relative to their moving averages. The 2nd factor is that silver has refused to confirm gold's break to higher levels this year, and has instead sat below an important resistance level, forming a potential double-top. The formation in silver is not regarded as a genuine double-top, however, and a likely scenario is that after a sharp reaction below its 50-day moving average, silver will turn higher again and go on to break above the resistance. Any such reaction, however, would likely trigger a sharp reaction in gold and gold shares, which should be seized upon as a buying opportunity for reasons we will come to later.

A good example of the 1st factor is provided by the chart for Yamana Gold, shown below, which subscribers to www.clivemaund.com were advised to take at least partial profits in at the top a couple of weeks ago when it was priced at $7.36 - Yamana has dropped about 10% in the past two days. This chart shows a stock which had become wildly overextended, and was thus vulnerable to a substantial correction - and there are a good many others like it now that look set to correct significantly.

The second factor is readily apparent from a brief perusal of the 6-month charts for both gold and silver, placed one below the other. Some readers may recall that the last Gold and Silver Market updates were calling for an upside breakout by both metals. In the event this forecast turned out to be 50% right, because gold did as expected and has continued to advance, but silver refused to break higher, an unusual non-confirmation situation giving grounds for caution. Now some might reasonably claim that gold doesn't need silver's permission to go up, it can go independently - but this misses the point. These metals tend to rise together and when one of them goes up and the other doesn't it increases the chances of a reaction in both of them. That is the situation we now find ourselves in. True, silver could yet break higher, but yesterday's action, in silver of course, but also in gold and precious metals stocks indicates that a near-term period of correction is now beginning.

The danger of a correction has been building for a week or two, and on www.clivemaund.com we partially unloaded a number of these at top dollar, including Linux Gold, Northgate Minerals and Yamana Gold, and, yesterday, Rio Tinto, having bought them before or as their big rises began. The situation had become acute by Monday night which was the reason why an article was posted on the site before yesterday's open advising subscribers to take partial profits across the board.

The overbought condition of many stocks is of course reflected in the charts of the indices - on the 1-year HUI chart we can see the large gap that the index has opened up with its moving averages, and its overbought extreme shown by the related MACD indicator. It is also close to the return line of an expanding uptrend channel - although it COULD break above the top line of this channel, but this is regarded as unlikely.

On the long-term XAU index chart, we can see how this index has risen up towards a zone of strong long-term resistance where we would naturally expect a rapid advance to stall out, at least temporarily.

We will end on a positive note, a very positive note in fact, by taking a look at the 3-year chart for the HUI index. This chart reveals that, although very overbought and overheated short-term, gold stocks are in a powerful uptrend, having broken out of a large 2-year trading range late last year. It is clear on this chart that the new intermediate uptrend is still in its early stages, and that there is strong underlying support from the trading range at and below 260. The uptrend is expected to remain quite steep, and thus the upper channel line shown which has this time called a halt to the advance, is likely to be breached at some time in the future, as the advance is expected to be steeper than this trendline. Thus, although the near-term correction that it is believed to be upon us may result in significant damage to a good many stocks, as we have just seen with Yamana, it should also throw up a good buying opportunity, and profit-takers will need to be aware that the market will likely turn higher again very quickly. For this reason long-term investors should ride out any near-term reaction. The right way for investors generally to utilize a near-term correction is to adjust portfolios - take partial profits in those stocks that have become ludicrously overbought, possibly wait a while and reinvest the proceeds in those stocks which look strong, but have not become so overbought. Anyone selling at this time however needs to keep in mind that once the anticipated period of consolidation/correction ends, this market is likely to move ahead again quickly, so there is a real danger of being left behind.

Clive Maund, Diploma Technical Analysis

[email protected]

www.clivemaund.com

Kaufbeuren, Germany, 19 January 2006