Gold in 5 Charts

Some very interesting things are happing in the precious metals space that might point to higher prices over the next 12 months.

• At the end of 2013, gold put in a double bottom – an important bullish signal.
• From that double bottom, gold climbed to a high of $1,392 by mid-March and then retraced 50% – an important Fibonacci marker which confirms a bullish Elliot Wave pattern.
• U.S. Federal Reserve bond buying reductions have not hurt gold nor bonds, a surprising development that should remain bullish for gold throughout the remainder of Fed tapering.
• The S&P/TSX gold producer index held above an important multi-year low, with mining stocks showing better values than the S&P 500 broader market.

Add them all together and you get a good outlook for gold, and an even better outlook for its producers… for a while.

Let’s start from gold’s recent bottom.

1. Gold’s Major Support

On gold’s monthly chart below we note the recent double bottom (blue) at around the $1,185 level.

Source: TradingCharts.com

This $1,185 low is a critical level, since it stretches way back to the beginning of the December 2009 correction – gold’s last correction prior to the one just ended. Gold’s recent double bottom at $1,185 completely erases all gains that gold enjoyed from 2010 to its all-time high in September 2011 (green). In other words, gold’s recent bottom marks a 100% Fibonacci retracement (red) of gold’s last bull leg.

For the most part (not always, but usually), a 100% retracement is the most that a chart can handle while still keeping its long-term bullish trajectory intact. If gold had fallen below the $1,185 area, it would have meant an end of the bull run.

But as it turned out, the only thing gold has given back is its last bullish leg – just one bull leg out of four bullish legs since the run began in 2003. (Leg 1 = 2003-06. Leg 2 = 2006-08. Leg 3 = 2008-09. Leg 4 = 2010-11.) That means the first three bull legs are still holding – a bullish sign going forward.

In fact, as it looks presently, gold seems to have entered into a new bullish Elliot Wave pattern.

2. A New Bull Run?

A typical Elliot Wave pattern is comprised of 3 bull legs alternating with 2 corrective legs. As noted in gold’s daily graph below, we have already seen bullish leg 1 and corrective leg 2, and seem to have entered bullish leg 3.

These are to be followed by a corrective leg 4 and finally by a bullish leg 5.

Source: TradingCharts.com

When? We have two metrics to go by. The first relates to price. Notice where wave 1 ended? It wasn’t a coincidence that it stopped just shy of $1,400, which happens to be a major level of resistance dating back to June of last year. Wave 3 needs to break above that level. If it does, then we have a bona fide Elliot Wave pattern on our hands, and can expect wave 5 to give us a major kick up to $1,550 or $1,600 – a major area of previous support and resistance.

The second metric we can go by is time. Wave 1 ran some three months from December to March, while corrective wave 2 ran for one month. These are in line with Elliott Wave spacing. Projecting forward, wave 3 should last from April to June, with corrective wave 4 in July. Historically gold has two annual bottoms – December/January and June/July. That pattern looks poised to repeat again this year.

The final bullish leg 5, then, could start in August and take us to the beginning of 2015. Wave 5 is historically the strongest and longest of the three bullish waves.

But wait a minute…Isn’t stimulus reduction by the U.S. Federal Reserve supposed to strengthen the USD and put a damper on gold prices for the remainder of 2014?

Apparently not.

3. Gold Seems Taper Resistant

Since the Fed started reducing its monthly bond purchases at the beginning of January, there have been three reductions totalling $30 billion monthly – a reduction of 35% of the original $85 billion of monthly stimulus.

You might have thought this should have devastated the bond and precious metals markets. But the graph bellow shows otherwise.

Source: BigCharts.com

As noted in green above, when tapering first began in January, investors started buying U.S. Treasuries (black) with yields at two-year highs, and gold (beige) with prices at 2.5-year lows. After a total of three stimulus reductions, investors have continued to pile into bonds and gold, as noted in blue. Why?

Three reasons, mainly. The first in due to anticipation. Ever since previous Fed Chair Bernanke first hinted at tapering back in May of 2013, investors had been exiting bonds and gold in anticipation of the tapers. Now that tapering has started, it’s a classic case of sell the rumor and buy the news.

The second reason is that equities are still red hot and over-valued. Investors are always on the hunt for better values, which can be found in bonds and gold versus equities at the moment.

The third reason is that bonds and gold never benefitted from this last round of stimulus (QE3) in the first place. When monthly purchases began in late 2012, bonds kept falling, yields kept rising, and gold kept falling too, as noted in red below.

Source: BigCharts.com

It stands to reason, therefore, that if neither bonds nor gold gained from the Fed’s monthly buying program (red), then neither would they suffer losses during its reduction (green).

However, this does not mean gold is resistant to all Federal Reserve policy. Gold’s arch nemesis has traditionally been interest rates. If the Fed sticks with its plan to terminate its monthly bond buying program by around Q3 of this year, and if current Chair Yellen’s general estimate of interest rate hikes six months later is on target, interest rates might begin to rise by the spring of 2015. Gold may reach a short-term top then – right at the end of the Elliott Wave pattern.

4. Stake Your Claim With The Miners

Add it all together and we get at least three bullish indicators for gold – a double bottom of support which held, the beginning stages of a bullish Elliott Wave pattern, and an apparent immunity to Fed stimulus reductions – at least until interest rates begin rising in early 2015.

How can we invest on it? You could buy some gold, silver, or other precious metal ETFs. But you might be better off with the producers instead. Note the graph below of the iShares S&P/TSX Global Gold Index (TSX: XGD) on the Toronto exchange, comprising 38 of the largest global gold producers.

Source: BigCharts.com

While gold was bouncing off of its 4-year major support level of $1,185 in December, the XGD was bouncing off of its 11-year major support level of 150 dating back to 2002 (blue). While gold is currently much higher than it was in 2002-03, gold producers are still stuck at those ancient levels. The miners are grossly undervalued relative to gold – and that means they have a much greater growth potential than the metal does.

The producers have taken advantage of the recent bullion correction to write-off enormous losses – especially in Q2 of 2012 – incurred from unproductive mines and costly acquisitions over the years. They whittled down their operations and have trimmed their fat like a boxer getting ready for the biggest fight of his career. Gold producers are lean, mean fighting machines, and their numbers show it.

Just note the following comparison of the S&P 500 index, the Market Vectors Gold Miners ETF (NYSE: GDX), and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ):

The prices of stocks relative to their companies’ book values show much better value for the gold miners (1.17 and 0.84) than for the broader stock market (2.28). In fact, the stock prices of the juniors are below book value by 0.16, meaning that you can buy them for a 16% discount below what their companies are actually worth.

Overall, the junior miners show better numbers than the S&P in all four metrics, including price-to-earnings.

While price-to-earnings may be a little high for the senior miners, this really isn’t an indication that they are overpriced, as shown by their low 1.17 price-to-book value. Rather, it means that traders are confident earnings will pick up dramatically, and are thus willing to pay a little more for the stocks.

Why such confidence? Because the shake-out in gold and other precious metals producers over the past two years has been long and deep. Expenses have been slashed and numerous mines have been closed. As bullion demand continues to grow in China, India and around the globe, supply will fall short, and prices will correct to the upside.

Until interest rates begin rising in 2015, the precious metals and their producers look precious indeed.

Joseph Cafariello