Sometimes A Gold Notion

08/02/04 11:31:49 AM

by David Penn

What if the March highs represented the end of a cyclical bull market in gold?

Security: GCZ4
Position: N/A

As the stock markets begin to roll over in the middle of 2004, many a broad-minded market watcher must have realized that a number of bold predictions -- by both bears and bulls -- are coming close to "rubber-meets-road" moments. If there is to be, for example, a "Crash" to be "Conquered," then it is hard to imagine a better time than the present -- with declining markets, soaring oil prices, a bitterly-contested presidential election campaign, the threat of terrorism and "pre-emptive war," record levels of personal indebtedness, anemic job growth, etc., etc. -- for such an event to begin.

One of the shoes that is supposed to drop during the alleged coming deflationary depression is the price of gold. This has been an interesting sticking point for those bears who are sympathetic to the varieties of "crash rhetoric" provided in recent years by analysts, money managers and observers as diverse as Bill Fleckenstein, Robert Prechter, Bill Gross, Richard Russell -- among many, many others. There are plenty of bears looking forward to lower equity prices; the problem is that many of these bears are simultaneously betting the ranch on gold. And the deflationary depression scenario calls for the price of gold to plunge right along with everything else (save the relative value of cash).

To that end, I wanted to consider a technical worst-case scenario for a declining gold price. Back at the beginning of the month, in a piece called "A Golden Zigzag" (Traders.com Advantage, July 6), I argued the case for a milder correction to the bull market in gold that began in 2001. The crux of the argument was that gold was nearing a zigzag type of correction. Such a correction suggested that the first move after the initial decline (the "b" wave) would be rather weak and would lead to a particularly strong resumption of the decline (the "c" wave). Such a "c" wave could take prices below the level where the "b" wave began.

No new highs vis-a-vis July likely means a test of the May lows in August.

Graphic provided by: Prophet Financial Systems, Inc..

I believed this correction would be an accurate reflection of what would happen to gold prices in the event that gold, during its "b" wave, did not retrace more than 61.8% of the initial decline (the "a" wave). Basis December, this would have meant a rally from the May lows of 376 to $413.70 or higher. As it turned out, the rally high in July fell short (the highest intraday print was $412.50), and gold moved lower. Based on the zigzag interpretation of the correction, this means that December gold should resume its bear market. The bounce from the July lows going into August should not take out the July highs, and the correction that should follow that bounce should take out the May lows. Because "a" and "c" waves in zigzags are often equivalent (or, better to say, the "c" wave will be at least as long as the "a" wave), the zigzag interpretation calls for a correction low in the neighborhood of $351.50.

Not great if you're a gold bull, but not a terribly severe correction -- especially if your interest in gold is longer-term than a few months. But what if, rather than merely a correction, the April top represented the end of a cyclical bull market in gold and the beginning of a cyclical bear? If the same sort of impulsive, five-wave movement that characterizes primary market swings is applied to gold moving downward from the April top, how far down might the price of gold drop?

In such a scenario, the decline into the May lows would represent a wave one down and the rally into the July highs a wave two up. A simple swing rule interpretation of the next leg down would call for a swing low of $339.50 -- should gold prices fall back below support at $376. However, should gold enter a new, five-wave impulse sequence down, the damage to gold could be far worse. For example, using Fischer's method to calculate a likely wave five bottom (assuming a wave one from $437 to $376), we arrive at a potential wave five low at $277.30.

How so? Wave one would measure at 61 points which, multiplied times 1.618, gives us 98.698. This number is then subtracted from the value at the wave one low (376) for a final result of 277.30.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Sometimes A Gold Notion

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