Gold Rally has Begun

Gold futures bottomed Friday, May 26th on the Comex - and should begin rallying into June. Although a slow, meandering start can reasonably be expected, the ultimate bottom-as we asserted in March-was seen last September and on a short-term basis, the bottom in its latest declining phase was registered May 26th.

We base our analysis on the high volume two-day double-bottom pattern seen in today's market. After registering a closing low of $270.70 on May 25th, gold briefly tested this precise level before bouncing higher to close at $272.20 on trading volume of 56,143 contracts (compared to yesterday's 15,927 and the average of 27,000). Clearly, the buyers are convinced the bottom is in and are now entering with force.

Equally comforting for the longs is the fact that open interest on Comex gold futures has been declining throughout the past few weeks, even as gold's price continued to slide (albeit in a sustained fashion). This indicates that the sellers were not committed to riding gold's latest downward move while being net short. Apparently, the powerful rally of last fall was enough to convince the shorts to avoid over-extending again, and short interest has clearly dried up in the wake of the September Massacre.

From a chart perspective, a noticeable declining wedge-a bullish pattern-has formed and is apexing at just over the $270 level. Prices tend to move slowly out of declining wedges (unlike with rising wedges), so we do not necessarily anticipate a rapid rise to considerably higher levels. Instead, a slow, steady upward trend should begin to assert itself beginning this week (in all likelihood) and throughout the duration of the year. What is more, a giant contracting triangle pattern in gold's long-term chart shows that prices are approaching the theoretical apex of the pattern, implying an upside breakout in the very near future.

Looking at the pattern of trading on the Comex the past few weeks yields many valuable clues as to gold's overall position in the current marketplace. Trading volume has been very light on the "down" days, and has tended to surge on "up" days-a sign of net accumulation among traders. As mentioned previously, the open interest pattern is also supportive of a bullish outlook.

Gold Stocks Even More Bullish

Further bolstering the bullish view, several leading gold stocks are exhibiting strong technical chart patterns, and many of them can be classified as buys. Iamgold [IMG.Toronto] is a low-priced mining company whose chart displays a deep parabolic formation (bullish) and has recently broken above a long-term downtrending resistance line. A similar pattern can be seen in Franco Nevada [FN.Toronto], which also recently broke a confining resistance trendline and has established an incipient upward trend. Volume patterns have been reflective of the accumulation pattern developing in this stock.

Aur Resources [AUR.Toronto] can be classified as a "breakout stock," as it recently exploded above its downtrend line to establish a new bullish trend. While the latest move is overextended and therefore due for a pullback, the five-year chart shows a developing parabola formation-a common theme in this sector. What this ultimately means is that a nascent bullish cycle has begun, and the upward part of the cycle is just getting started.

The recent volume patterns on the NYSE-listed Meridan Gold [MDG.NYSE] have been astoundingly bullish. There have been numerous high-volume upside closing days, wherein prices closed at or near the high point of the trading day, indicating forceful buying. Furthermore, Meridian's chart exhibits a characteristic common among stocks due a significant rise, namely, it has been consolidating (i.e., moving sideways) for the better part of the last year, previous to which a rise in price occurred. This price pattern, when coupled with the bullish volume patterns, suggests that the next markup phase of this stock will soon begin.

Among the blue chips, we find Barrick Gold [ABX.NYSE] exhibiting one of the most clear-cut parabolic bowl formations of any single gold stock. The bowl pattern in Barrick's chart is even more conspicuous than the bowl in physical gold itself. This is definitely a bullish stock, and coming off of fresh lows makes Barrick an attractive buy.

Placer Dome [PDG.NYSE] is also etching out a bullish parabola in its chart, though it is not quite as developed as the one in Barrick's chart. However, a long-term downward trendline has been broken, and the downtrend has therefore been arrested. An incipient uptrend appears to be underway, though we must await confirmation before making commitments.

From a longer term perspective, we would reiterate our commentary of last month: "Based on our exhaustive cyclical analysis, we have concluded that the high-volume spike in gold prices in late September of last year was indeed the long-wave cyclic bottom in gold…Since the price and volume surge on the days of September 27-30 in Comex gold futures is quite conspicuous on the charts, we therefore conclude that this represented a major bottom in gold's price. But was this in fact the ultimate bottom in gold's price? To answer that we must perform what we like to call "parabolic analysis."…Looking at a long-term chart of gold prices, note how prices gently conform to the edge of the bowl pattern we have drawn…If we assume that the explosive price movement in gold futures last fall was the midpoint of the cycle (a high probability), then this will serve as the midpoint of our parabola, or bowl. By measuring the distance from the midpoint to the extreme left edges of the bowl and projecting that same distance and curve onto the right side of the chart-the side which represents the future-we have a guideline for how gold prices can be expected to perform in the coming months for the next four or five years. While there will almost certainly be some dragging along the bottom of the bowl, at some point the gently upward curving sides of the bowl will begin shepherding prices to higher levels until our upside target of approximately $400-$450 is met. From there, prices will probably correct and consolidate before rising again into the early inflationary leg of the next K-Wave cycle."

As we write this, gold's price has thus far been perfectly adhering to the sides of the "bowl," or parabola, that we have drawn. This lets us know that the developing upward cycle is still intact and should continue supporting prices in the months ahead.

Many ask, "How can gold offer value and financial protection in the period of late runaway deflation that we are entering?" It is true that gold's fundamental tendency is to lose dollar value during period of deflation. But when overseas markets and currencies are losing value relative to the U.S., investors in foreign countries seek protection in precious metals. With foreign stock markets beginning to crumble and currencies rapidly losing value, foreign capital flight will find a channel in gold investments, among other things. This, along with diminishing faith in global fiat currencies, explains how gold can appreciate in even in the most deflationary of economic environments.

We are entering the worst of all possible worlds-a deflationary cycle which will wreak havoc on equities prices, erode currency values, inflate certain staple commodity prices, and exert a lifting effect on interest rates. For the first time in nearly a decade, it is becoming quite expensive to be a debtor, since the value of debt is continually rising due to the strengthening value of the dollar, while interest rates are also increasing. In such a perilous economic milieu, it is the gold investor who possesses peace of mind, knowing his assets are safe from the ravages of the developing financial storm.