Now is the Time to Buy Gold

The final phase of accumulation appears to be ending in the precious metals markets, and the prices of gold and select mining stocks should begin a sustained ascending phase in late October/early November. Not surprisingly, the expected drop in the U.S. dollar index should commence during this same timeframe. We have been actively accumulating gold ourselves since April, incrementally stepping up our buying every month since. We can state with perfect candor and confidence that the outlook for gold will be undeniably bullish in the coming months.

A glance at the long-term gold futures chart highlights the underlying bullish influences behind the gold market right now. A clear-cut bowl formation is discernable on both a long-term and intermediate-term perspective (actually, two bowl patterns intersecting one another). Bowls in chart analysis always signify accumulation, since the underlying forces that form the bowl pattern must be supporting prices in order for the bowl to form. When trading volume and open interest patterns correspond to the shape the price line takes, the bullish implication becomes ever-more apparent.

In order to clarify our bullish analysis of the gold market, it will help to analyze the gold chart from a strictly supply and demand perspective. Chart patterns are nothing more than supply and demand in pictorial form, so this exercise will greatly aid the chart reader in making his trading decision based on underlying technical conditions. Technical conditions, it will be remembered, are nothing more than distilled fundamental conditions of a market. Learn to read them, and you will have mastered the science of discovering the overall balance of supply and demand in any given market.

The prolonged lateral pattern (with a slight downward tilt) is an area of either accumulation or distribution. Trendline analysis is an invaluable aid in determining whether supply or demand is exercising the greatest influence over market conditions. On the gold chart, a series of downward sloping trendlines can be drawn at successively higher degrees. This is known as "fanline analysis" since the form of the trendlines takes on the appearance of a fan. Note the chart we have drawn of Placer Dome (PDG), a major mining stock and a reliable leading indicator of physical gold prices. Placer Dome displays much the same pattern as the gold market itself, albeit with a more advanced bowl formation. Note the fanlines we have drawn on the chart. These lines represent the bearish influences of supply in the market, which acts to weigh down prices. When each line is broken, it indicates that demand has absorbed (i.e., accumulated) the overhanging supply in the market. When three consecutive downtrend lines are broken, it strongly indicates that net accumulation of existing supply has taken place and that the buyers are now in a position to move the market in their favor—to higher levels. In classical technical analysis this is known as a "fanline retracement" (see our book "Elliott Wave Simplified" for an in-depth discussion of this concept).

So from a strict supply/demand analysis, one can see the underlying bullish forces taking shape in the gold and mining stock sectors. This same phenomenon can be seen in the silver market as well, although to a lesser degree.

Volume analysis is important when undertaking to trade in any commodity or equity, since volume always precedes price. While volume analysis of commodity markets tends to be more difficult than for equities (for obvious reasons), a reliable means of interpreting gold trading volume is nevertheless within the grasp of the enterprising analyst. We have learned the relationship between price action and volume from our years of watching the gold tape and have discovered a means to translate this differential into a single indicator—the "Midrange Volume" (MRV) indicator. This indicator measures the buying vs. selling power in each day's gold trading session and translates it into the form of a line chart. The latest reading of our MRV indicator shows the firm presence of accumulation in the gold futures market. Simply put, insiders are buying gold.

While supply and demand analysis is important, time cycle considerations take precedence. This is one area of market analysis that has remained largely ignored by most analysts, even though it is the single most important factor in forecasting price movements. Those relatively few analysts that do acknowledge the value of cycles tend to misuse it, not fully understanding how to read cycles in charts. When the gold market is analyzed from a cyclical point of view, the underlying bullish factors behind the yellow metal become even more apparent.

Cycles are preeminent in the realm of finance since time (the underlying basis behind cycles of all lengths) is the least common denominator of everything in this temporal plane of existence in which we live. By isolating important tops and bottoms on price charts along with accompanying spikes in trading volume, a regularly occurring cycle rhythm of various degrees can be discerned. The prime family of cycles that govern gold's price movements over time include the six-year cycle, the 12-year cycle, the 20-year cycle and the 50-year cycle. Most of the cycles that influence gold prices are harmonically related. Take, for instance, the six-year and the 12-year cycles. An important bottom was registered for almost all commodities in the fall of 1998, which time marked the bottom of the 8-year and 12-year cycles. Since that time, the broad commodities sector has been rising due to the fact that the underlying cycles are in the most dynamic portion of the rising phase. All cycles can be divided into two phases of exactly equal lengths: the rising phase and the declining phase. Under the right set of circumstances, prices can still rise in the early portion of the declining phase of a given cycle, but the last 8-12 percent of any given cycle is always the hard downward phase, meaning that prices will always decline in this portion of the cycle. Fortunately for gold, the metal has already survived this hard downward phase of the previous cycle, and a new series of cycles began in 1998 and 1999 (with yet others to begin this fall) which will force gold prices higher over the next several months. By our cycle analysis, that time should begin no later than the first week of November.

The U.S. dollar, which tends to trade in inverse fashion to gold, will begin a sharp decline at that time, further adding fuel to gold's incipient bull market. Gold's intermediate-term (i.e., six-month) price projection, based on our analysis, is $400-$450.

Yet another cyclical factor that must be borne in mind when analyzing the gold market is the fact that of all the major commodities, gold is one of the very few that has not benefited from the 1998 intermediate cycle bottom. Undoubtedly this is due to the adverse impacts of manipulation of gold prices, but history shows that when the upward influence of a cycle is hindered by outside manipulation (i.e., not inherent within the natural forces of supply and demand), prices always make up for this lost time and movement by overcorrecting. This means that when gold finally starts moving higher, it will do so with a vengeance. The free market will not suffer human manipulation for any great length of time and will always duly punish it.

Speaking of long-wave economic cycles, it will do us well to examine our current position relative to the Kondratieff Wave. The K-Wave, it will be remembered, is a 60 year long-wave cycle which exerts its force principally on the commodities market, but by extension, on the equities and bond markets as well.

The present K-Wave—with its 60 year rhythm—began in 1949 with the bottom in corporate bond yields and consumer prices. Typically, the commodities sector—led by gold—will experience a crash and will deflate the better part of two decades from the peak in prices until the bottom. The two legs of the K-Wave are divided equally between K-Wave inflation and K-Wave deflation. Both legs are equidistant, so that once the first (i.e., inflationary) leg is complete, one can know in advance the exact leg of the corresponding deflationary leg since the deflationary leg is always equal in time to the deflationary leg…with a twist. The K-Wave inflationary leg for commodities tends to last 40 years followed by 20 years of deflation.

For equities, K-Wave inflation gives stocks a mostly upward bias for about 50 years, followed by 10 years of deflation. This pattern held true in the first half of the century, with the K-Wave deflationary leg commencing in 1920, at which time commodity prices began a long and precipitous slide. Stock prices continued higher, buoyed by the forces of efficiency that early inflation tends to produce for corporations (excluding commodity-based businesses). Then, late runaway deflation takes hold, forcing stock prices lower, as it did in 1929 and throughout the 1930s. The K-Wave deflation in commodities ended in 1940, at which time grains prices and other basic commodities began reflating (really, this 10 year period in the K-Wave should be called "reflation" even though it's technically classified as part of the deflationary leg). Ten years later, in 1949, a new bull market was born.

So where are we in today's K-Wave? The K-wave inflationary leg which began in 1949 topped out in 1980-81, harbingered by the crash in gold and commodities prices. We are now 20 years into K-Wave deflation—with 10 more years to go—and already commodity prices show important signs of having bottomed. This means the next 10 years will likely be reflationary for most commodities. However, stocks have still not deflated and we have just entered the final third of the K-Wave downward leg—known as "late runaway deflation." Since any asset that inflated during the earlier part of the K-Wave must be deflated at some point, it follows that equities should begin deflating early in 2001. This assertion is based on the fact that the final Kitchin Cycle (a.k.a., "Business Cycle") is due to come down around that time. The Kitchin Cycle is a constituent of the K-Wave structure.

All things told, based on our position the K-Wave, year 2001 should be a time of collapsing equities prices and imploding debt the world over. Concurrently, it will also likely be a time of rising precious metals prices.

We would be remiss if we did not refer to the latest gold market analysis from friend, colleague, and market mentor Samuel J. Kress, editor of the SineScope Cycle Letter. Kress is one of the foremost practitioners of financial cycle analysis in the country. His official market timing record for the past five years, benchmarked off the Rydex family of mutual funds, is nearly flawless. He currently ranks number one in the country in timing the Rydex equity funds and hardly ever misses a turn in the cycles, irrespective of timeframe. In his latest report, "Taming the Bear," Kress writes: "Gold benefits from both latter stages [of the K-Wave]. For the most part, the price of gold at these latter stages is not a function of its inherent supply/demand condition. Rather, it is predominantly psychologically reflecting the premise it is not what something is but what it is perceived to be. This can be compared to equity P/E ratios. While earnings might not change, P/E ratios can increase from around the market's average to mega times and, conversely, can decline from mega times to a market average or below.

"When the latter stages of inflation begin, gold is perceived as the ultimate hedge. During hyper-inflation of the 1970's, gold increased in value approximately 20 fold, and then began its bear market in the early 1980's with disinflation. When deflation/depression begins, the price of gold is perceived as the ultimate storehouse of value. Based on our long-term cycles, the nearly 20-year bear market in gold should be in the process of ending, and the first 5 years, at least, of the decade of 2000 should be a bull market in gold. An old adage exists: 'The old general's fight the old wars.' These conventional soldiers continue to evaluate gold in the context of the quandary whether inflation is in the process of re-emerging. Assuming our cycles exhibit continuity, sustained inflation might not begin to re-emerge for many years to come, but rather it is deflation and depression that are imminent.

So where does Kress project the price of gold over the next five years based on his ultra-reliable cycle work? His best "guestimate" is $2000/oz."Gold, or a 'derivative," should represent upwards of an average weighting in a portfolio with a dollar averaging approach during the [1999-2000] year," he advises.

Regardless of what gold's ultimate price objective will be (and we do not pretend to have the answer), of this much we are certain: Year 2001 will represent a time of overall rising precious metals prices and will be a time of great profit for gold traders who favor the long side of the market.

[Note: Clif Droke may be heard on the daily one-hour financial talk show "Genesis Money Watch," broadcast Monday through Friday, 3-4 CST (4-5 p.m. EST), on the Genesis Communications Network. Visit their Web site at www.gcnlive.com for a station listing or to listen live online.]