A Bull Market in Gold?

01/22/02 01:12:38 PM

by David Penn

The spring of 2002 should feature a battle between a year-old bull and a six-year old bear.

Security: $XAU
Position: N/A

Bull markets in the precious metals (as opposed to more industrial metals such as copper) tend to reflect a relative devaluation of the dollar. While gold and silver may not have quite the "safe haven" investment status they once had, increases in the prices of these precious metals often signal concern over the strength of the greenback and, by extension, the U.S. economy. Anyone who recalls the inflationary 70s and $800/oz. gold in 1980 will understand the inverse relationship between a floating dollar and the prices of precious metals.

But gold and silver have been lousy investments for more than five years, as the primary bear market in the Philadelphia Gold & Silver Index ($XAU) shown in the chart below makes plain. This primary bear market does look to be experiencing its second major secondary correction, or countertrend rally, however. The previous secondary correction in the $XAU--from the low of 48.7 in September 1998 to a peak of 92.7 in October 1999 (a gain of 90%) to the point where prices broke the uptrend line in January 2000 (at 68.9, for an overall correction gain of 41.5%)--lasted about 16 months, compared to the 14-month run of the current secondary correction.

A previous secondary reaction failed at the six-year downtrend line. Will the current reaction turn into a sustainable rally?

Graphic provided by: MetaStock.

The current secondary correction, which began in November 2000, advanced from 42.1 to a peak of 66.5 in May 2001, before retreating and ultimately breaking its uptrend line in October 2001 a 58.8. Although the index was last at 59, suggesting a successful rally from the trendline break, a similar trendline break anticipated the end of the previous secondary correction at the beginning of 2000. This, in addition to the fact that the current secondary correction has already achieved an overall correction gain of about 40%, suggests that the bull market in gold and silver may have run its course.

In fact, any continued advance in the 14-month bull market would send the $XAU hurtling into the six-year primary bear market gold and silver have been in ever since descending from pre-deflation levels in the mid-1990s. The downtrend line of this bear market has been tested once, in September of 1999, but the correction from that rally was swift as the $XAU lost 22% in one month, then another 33% before bottoming in October 2000.

It is possible that gold and silver are establishing a bottom, although in addition to the basing action between mid-1998 and mid-1999 prices would need to stay above intermediate correction lows of 45 (April 2001) and the current bottom of 42.1 (October 2000). This would leave only greater resistance to any future upside move; there is at least six months worth of consolidation in the second half of 2001 that would have to be overcome for any advance to represent a significant bullish reversal--much less a change in the primary trend. Should gold and silver breakout on the upside of the six-year downtrend line, however, then the most obvious point of major resistance would be the previous rally high in the fall of 1999. Nevertheless, given the persistence of the bear market in gold and silver, the inter-rally high of 66.5 in May 2001 should prove to be plenty of resistance against which precious metals can finally show what they can do.

David Penn

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

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