Gold at the Crossroads

Gold futures on the COMEX saw an impressive upside run this past week, closing up to $297.60 as of Friday. This is certainly a sign of underlying technical strength in gold on an immediate-term basis. While we are still long-term and even intermediate-term bullish on gold - its weekly chart pattern alone projects an upside of nearly $345 - we are concerned over the extreme bullishness that is ubiquitous among gold traders in recent weeks. This would ordinarily be taken as a sign that a short-term reaction is due.

A well-known measure of market strength is known as the "Magazine Cover Indicator," which simply stated speaks volumes about the true state of a market from a psychological standpoint. The thinking behind this indicator is that whenever news magazines start putting gold (or any other stock or commodity for that matter) on the front cover, the trend has been exhausted (at least on a short-term basis) and a reversal can be expected. Well we know of at least one news magazine that is planning to feature gold on the front cover of its April issue (due out on newstands next week). From a contrarian standpoint this would typically be met with selling. Perhaps this time is different; perhaps we are letting our contrarian nature get the best of us, and perhaps we have underestimated gold's short-term strength. But we are still not 100% convinced that last week's gold rally will follow through all the way above the $308 intra-day high without a reaction first. Only when gold closes above the $304 closing high will the short-term trend turn up decisively.

Gold's three month cycle chart shows the latest series of channels in the upward phase to around $304-$306, at which point the peak occurs and resistance will be encountered. Gold will almost surely pullback upon achieving $304, if for only a brief rest. What happens after this will largely determine the next six week trend (gold's short-term cycles are configured to run in six week increments, with the most recent upward trends running in six week spurts). Should gold rally back above $304 after the first test and successfully move above it, it will signal that gold has finally broken that critical $300-$310 resistance band that has proven fatal to gold rallies for the past few years. A failure to break above $304 on a closing basis in the next couple of weeks endangers the short-term up-trend and warns of further consolidation ahead.

Also worth considering is the fact that the $304 level (besides being a recent resistance level on a closing basis) is where any further gold rallying will meet the top of a five-month parallel channel. This should prove to be an interesting technical test for gold, assuming its follows through with its rally in the coming week. Also, $304 is the precise top where a shorter 6-week channel will be met this week; not coincidentally, $304 could also be considered a "natural" resistance level in W.D. Gann's Square of 20 chart. As you can see, gold must successfully cross $304 to have our full vote of confidence in the short-term.

On an intermediate-term basis, gold is currently trading within the confines of constant-width curved channels (which are distinguished from our proprietary "cycle channels") with the sub-minor trend channel having a $3 width, the minor trend channel having a $6 width, the sub-interim trend a $9 width, the interim channel an $18 width and the long term channel a $27 width. All the channels are up except for the interim channel, which tops around the $308 recent highs and will provide resistance for any further gold rally, although how much resistance is open for question since the long-term channels is up. A short-term declining parallel channel with five lines of magnetic support/resistance was established with the September-October 2001 highs and will be encountered this week at $304. As we mentioned above, a penetration above this channel series at $304 would be bullish, but a failure to penetrate above it in coming days would mean a likely test of at least $290-$292. Interestingly, this is where a series of short-trend lines and channels all converge on the chart, which would seem to make it a magnetic support level "destined" to be tested (although nothing is ever 100% certain in the markets). Also, the $290 support area is a major supporting base along the Gann Square of 20, for which the gold market is admirably suited.

Looking further out, gold had its most recent 120-week cycle bottom (the dominant trading cycle) early in the second quarter of 2000 and won't have another one until around January 2003. That leaves a good part of 2002 for gold to experience more upside once the latest short-term weakness is completely worked off. Gold sub-dominant 40-week cycle bottomed last in February, along with the dominant short-term 20-week cycle and the 24-week cycle. This is what led directly to gold's impressive rally from the low $280s to around $308 on an intra-day basis a few weeks ago. The move to $308 decisively broke gold's price line out of a more than six-year declining parallel channel that began technically in 1995. As long as prices can remain above $280 in coming weeks (extremely likely) it will confirm that the long-term downward trend in gold has formally been broken and a new upward trend is emerging. Cyclically, we got confirmation back in late 1999 that the long-term bear market in gold was over (as we have written over the past couple of years) since the dominant long-term cycles all bottomed in the fall of that year, producing a magnificent rally. This was at a time when the bull-to-bear ratio on gold was at a historic low and gold was coming off extremely oversold levels, adding even more confirmation to the ending bear market.

A word about the K-wave is in order. This long-wave economic cycle, which averages to 50 years in duration, is due to bottom sometime in the middle of this decade (2004-2006). While predicting a precise bottom is not possible, we at least know that we are now in that final "hard down" phase where the extreme deflationary pressure of this dominant economic cycle has begun making its presence known across the broad economic spectrum. Many market students do not concern themselves with the K-wave and contend that its effects can be muted by government intervention. While this is true to some extent, it must be pointed out that no amount of government or central bank influence can totally alter or obliterate the K-wave and its effects. In fact, central intervention can actually make things worse over the long run.

One important consideration that must be kept in mind is R.N. Elliott's "Rule of Alternation" (Elliott was the discoverer of the famed Elliott Wave Theory of stock price interpretation). Elliott observed that in all markets across all time frames, prices alternate between up and down, bull market and bear market, upward trends and downward trends. He made the further discovery that not only does market action alternate between extremes in amplitude and duration but also in terms of severity. For instance, if the last bear market a particular stock or commodity experienced was a mild one, the next bear market should be severe, and vice-versa.

Well the last K-wave bottom in this country was relatively mild and the economy hardly even showed any ill effects when the last K-wave bottomed in 1954. This year was also one which saw the 60-year Financial Cycle bottom, which is half the 120-year Master Cycle. The previous K-wave/Financial Cycle bottoms were severe, which also represented the 120-year Master Cycle bottom of 1894. This timeframe of the mid-1890s through the early 1900s was one of severe industrial depression, especially around 1894. So basically we have a pattern where the first K-wave bottom of the 20th century was severe, the second one of that century (in 1954) was mild, and the one we are now approaching (2004 ETA) should therefore be severe based on the Rule of Alternation. This is one reason why we are long-term bearish on stocks and the economy, to say nothing of the falling 120-year Master Cycle which bottoms in 2014.

The years ahead should be challenging ones to say the least. This is one reason why in the overall picture, gold should perform quite admirably as both an investment and a store of value over the next few years.