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Gold/HUI Divorce ? part II

 

By Eric Hommelberg        Printer Friendly Version

May 24, 2005

  www.golddrivers.com

NOTE : This article is an update on 'Gold/HUI Divorce ?' of April 29. This article not only discusses the Gold/HUI ratio again but applies some 'relative' analysis on the HUI, Gold and Dollar as well . As expected it only confirmed what the Gold/HUI ratio already predicted : HUI bottom must be very near. END.

Emotions are running high these days when it comes to future prospects of the once almighty HUI. After a stunning 3-year run which launched the HUI by more than 600% the HUI seems to be getting old and tired and running out of steam. More and more investors gave up the idea of recovery and said good bye to Mr. HUI
Now what to expect from the HUI from here ? Is the bull market in gold stocks over ? Are we heading for HUI 100 as some analysys do suggest ? Or can we expect a new bull run towards new highs ? Well, difficult questions which deserves serious attention.

This article will focus on :

HUI short term, ready for bounce ?
HUI long term, bull market over ?

HUI short term, ready for a bounce ?

In my article 'GOLD/HUI Divorce ?' of April 29 I explained that bottoms in gold stocks are often characterized by an extreme undervaluation of the gold stocks compared to gold. These undervaluations are clearly visible in the Gold/HUI ratio chart. Now the Gold/HUI ratio is again at such extremes that something simply has to give since such extremes won't persist for a long period of time and yes, most of the time they've proven to be (gold/hui ratio extremes) a reliable indicator for approaching bottoms in gold stocks. (see chart below)

As this chart shows the Gold/HUI ratio moved far ahead of its own 200 dma (blue line). When an item moves too far ahead from its own 200 dma and gets overextended gravity will pull it back (see next HUI chart) . The current reading of the Gold/HUI 200 dma is 2.05 therefore it's likely that the Gold/HUI ratio will meet its 200 dma again at much lower levels than its recent reading of 2.53.

Conclusion :

Gold stocks are extremely undervalued compared to gold. This becomes visible by an extreme high RSI reading in the Gold/HUI ratio and a tremendous over-stretch of its own 200 dma. Therefore the Gold/HUI ratio will meet its 200 dma again most probably at much lower levels than its recent reading of 2.53. Lower Gold/HUI rating translates itself into higher HUI levels most of the time (unless the price of Gold drops rapidly)

In my article 'Gold/HUI Divorce ?' I presented a HUI-chart which showed that severe oversold condition (over-stretch of its own 200 dma to the downside) were mostly solved by a return to its long term average (200 dma), see again chart below :


This chart clearly shows that severe oversold conditions are often solved by a return to the long term average (200 dma) indeed, no matter what the current trend is (bull or bear)

Why do I come up with these examples ? Well, because there's a lot of discussion right now re the HUI's future outlook. Many analysts suggest that the bull market in gold stocks may be over and that we're in a bear-trend these days which could last for a long period of time.

Now even if that were the case, still a severe oversold condition has to be worked off. As the chart above clearly shows, even in a bear-trend a severe oversold condition often leads to powerful short term up-moves.

Now let's take a look at today's HUI chart, is it really that oversold ? Do we see a severe over-stretch (to the down-side) of its own 200 dma?

Just take peek at the chart below and judge yourself :


This chart clearly shows an oversold HUI by all means. Low RSI readings, low MACD readings and a tremendous over-stretch of its own 200 dma to the downside.

We already saw that any item which moves too far ahead of its own 200 dma will be pulled back sooner or later. In other words a strong anomaly (downwards) from the 200 dma could be considered as a (short-term) buy-opportunity. Again no matter if the current trend is bull or bear.

The 200 dma deviations (actual reading vs its own 200 dma) never exceed a certain limit. I mean we'll never witness a HUI trading at 5 times its 200 dma . During the HUI bull market over the last 4 years, the HUI only exceeded its 200 dma by 40% (times 1.4) twice. On the downside the HUI only dropped below its 200 dma by 10% (times 0.9) twice.

So by charting the HUI against its own 200 dma and marking the 40% and -10% areas as being selling/buying zones you should get a good indication of its current condition (overbought/oversold). It's a simple concept which picks the extreme over/under valuations quite easily. This concept has been given birth by gold-writer Adam Hamilton. He dubbed this whole concept into 'relativity' and wrote some brilliant pieces in which he practiced this simple but powerful concept (eg The Relative Dollar and Gold).

Now back to the HUI charts. When we chart the Relative HUI (rHUI) on top of the HUI chart itself in a combo-chart you'll notice that the extreme HUI undervaluations of the last three years were perfectly nailed by the Relative HUI chart thereby providing solid 'BUY' signals. See chart below :


http://www.golddrivers.com/chartpages/relativedollar.htm

This 'relative' HUI/HUI combo-chart suggests a 'relative' HUI (rHUI) falling below 0.9 provides a good 'BUY' opportunity ! Therefore its current reading of 0.79 makes a much further decline of the HUI highly unlikely.

Conclusion :

Short term : HUI is so oversold and undervalued against gold that a further decline seems highly unlikely. The Gold/HUI ratio and the 'relative' HUI both suggest an upward bounce (at least for the short term) no matter what the current overall trend is (bull or bear). According to its own history such a bounce could launch the HUI towards its own 200 dma. Therefore a (short term) bounce towards the 200 level shouldn't be categorized as being 'science-fiction'.

HUI long term, bull market over ?

Many analysts do suggest that even if the HUI manages to make an upward bounce (in order to work off a severe oversold condition) its gain will be limited by its 200 dma before continuing its downward trend since Dec 2003. Now, is the HUI bull run history indeed? Or should we prepare ourselves for the next move up ?

Well, it all depends on the price of Gold imo. Higher gold prices mean higher gold stock valuations, it's as simple as that ! Before we go further let's check out if that is and has been the case of late.

Higher Gold prices mean Higher Gold Stock valuations ?

Some analysts claim that gold stocks could be in a bear market while gold itself could remain in a bull market. Analysts projections of a HUI decline towards 100 while bullish on gold confirm the extreme bearish sentiment towards the gold shares these days.

Statements that gold stock valuations have nothing to do with the price of gold is denying that the rise of Durban Deep from 50 cents towards $50 in the late seventies had anything to do with the sharp rise in the price of gold. Mining companies do have gold reserves. When gold prices rise, the net value of the company's gold reserves rise and so will company's total net worth !

It's easy to check out if there's a strong correlation between gold and gold shares indeed. Just chart the gold price vs the HUI and judge yourself :


This chart proves beyond any doubt that gold shares do have a strong correlation with gold prices. Also clearly visible is the tremendous Gold/HUI spread these days. This is a huge anomaly which has to be solved by sharp rising gold stocks or a rapid decline of the gold price.
So if the gold price is so important for the HUI's future direction we should focus on gold's prospects now. Gold has showed weakness since early this year and many people wonder if we should say good bye to our beloved gold bull. In order to answer that question I would consider myself first :

'What is the future trend of the dollar ?' Why ?

Because there is a very strong correlation between the dollar and gold. If the dollar goes so will gold but in opposite direction.

Still some analysts try to put gold in a commodity box and are happy to explain rising gold prices mainly to producer de-hedging activities. I don't agree with that kind of reasoning. When you consider that the paper-gold market is about 35 times larger than the physical gold market it should be obvious that a tiny 300 tonnes producer de-hedging don't have that much effect in the face of a massive 120.000+ tonnes of paper-gold traded every year. Sure, producer de-hedging helps to underpin the price of gold but it's not determining its primary trend. Producer de-hedging is a consequence of a higher gold-price (expectation) but it's not causing it.

So what determines the primary trend of gold ?

Well, the primary key-driver for gold remains the dollar, no matter how you slice it.

Gold is the primary driver for gold since gold trades as a currency and has proven to be a perfect hedge against a declining dollar, it's there for everyone to see. If gold and the dollar move in opposite direction than we should see a similar pattern if we chart gold against an inverted dollar . Is that the case indeed ? My guess is yes, see chart below and judge yourself :

This chart clearly shows that Gold trades like a currency. Gold is the anti-dollar !
Needless to say that a further dollar decline will launch the gold price.

Convinced about the gold/dollar relationship ?

Now let's focus now on the dollar itself. The dollar is in a bear market for more than three years now, see chart below :


http://www.golddrivers.com/chartpages/goldhuicharts.htm

This chart clearly shows the bear trend of the dollar over the last three years.
Now, any item which remains in a bear trend provides excellent sell- opportunities when that items approaches or penetrates its own 200 dma. Again any item which moves too far ahead of its 200 dma will be pulled back sooner or later (also called 'counter-trend' rally)

Also this dollar chart confirms this thesis. We've seen a couple of counter-trend rallies so far and all provided us with some excellent 'SELL' opportunities at or near its 200dma. We've had a perfect sell opportunity in August 2003 when the dollar index penetrated its own 200 dma (this marked the end of countertrend rally I) and hit 99.49, we've had a perfect sell opportunity in May 2004 when the dollar index penetrated its own 200 dma (this marked the end of 'counter-trend' rally II) and hit 92.29 and it seems that we're heading for a nice selling opportunity again since the dollar index penetrated its own 200 dma again at 84.75. Does it mark the end of 'counter-trend' rally III ? (see chart above). Hard to say but the fact that the RSI indicator marks an overbought condition as well makes the case for a further dollar up-move increasingly difficult.

Now when we apply the 'relative' concept on the dollar chart again just as we did on the HUI chart we should get a good indication of its current condition (overbought/oversold). Again I've charted the 'relative' dollar (rDollar) on top of the dollar itself in a combo-chart, see below :


http://www.golddrivers.com/chartpages/relativedollar.htm


This combo-chart of the rDollar and Dollar itself suggests that a rDollar exceeding the 1.00 level provides a good 'SELL' opportunity ! It did so anyhow for the last three years. Therefore current reading of 1.02 makes a much further rise of the Dollar highly unlikely.

Of course relative analyses can fail. When could it fail ? It could fail at the turn of a bear market into a bull market. But as long as the dollar remains in a bear-market the relative dollar chart continues to provide pretty good 'SELL' indicators. Again it did so for the last three years.

It goes far beyond the scope of this article to discuss the dollar fundamentals but readers interested could read chapter II of the Gold Drivers Report 'GOLD & US$' which makes a strong case for a continued bear market in the US$.

Now last but not least let's have a look at the relative chart of gold itself. Again I've charted 'relative' gold on top of gold itself in a combo-chart, see below :


http://www.golddrivers.com/chartpages/relativedollar.htm


This combo-chart of rGold and Gold itself suggest that a rGold falling below the 1.00 level provides a good 'BUY' opportunity ! It did so anyhow for the last three years. Therefore current reading of 0.98 makes a much further decline less likely.

Future scenario ?

Again, no-one can predict the future but nevertheless it's fun to speculate about future possibilities. Now if the dollar remains in a bear-market in which I think it will, than we're approaching now the end of 'counter-trend' rally III (see three-year dollar chart). What you'll notice is that the end of a 'counter-trend' rally usually marks the beginning of a multi-month decline (> 6 month). No here it gets interesting since the greatest rises in gold happened to start at the end of previous dollar 'counter-trend' rallies.

The end of 'counter-trend' rally I occurred in Aug 2003. Gold started an impressive rally then which took it $70 higher ($360-$430)

The end of 'counter-trend' rally II occurred in May 2004. Gold started an impressive rally again which took it almost $90 higher ($371-$456)

The end of counter trend rally III in May/June 2005 ???. Another Gold move in the make of $70 - $90 ??

Previous up-moves in gold which started from ending dollar 'counter-trend' rallies lasted 5 - 7 months launching gold by $70 - $90. Another 5 -7 months up-move in gold taking it up by $70-$90 brings us $500 gold before year end or shortly thereafter.
Weird idea ? Don't think so. Even GFMS which is always very conservative with its price predictions wouldn't be surprised to see $500 later
this year.

Dollar could push gold to $500 level in 2005
By Kevin Morrison
Published: April 28 2005

Gold prices could reach $500 a troy ounce this year if the dollar continues to be forced down by concerns about the twin US deficits, said GFMS, the precious metals consultancy, on Thursday.

"We are reasonably sure that we will see a $470 or $480 gold price, and I think there is a distinct possibility that we could see $500 this year," said Philip Klapwijk, executive chairman of GFMS, at the launch of the group's 2005 gold survey. END

It should be obvious that if the dollar remains in a bear-trend indeed gold will resume its upward trend soon. If Gold resumes its uptrend soon then the Gold/HUI extremes can't be solved without much higher gold stock prices.

Highlights :

Dollar reaches overbought condition which makes a further up-move increasingly difficult.


Relative dollar chart suggest a top nearby for the dollar as well.

When Dollar resumes its bear trend of last three years gold will go but in opposite direction since gold is the anti-dollar and trades like a currency.


Dollar could be very well in its latest stage of a 'counter-trend' rally


Previous ends of dollar 'counter-trend' rally marked the start of giant gold up-moves ($70-$90)


If Gold resumes its uptrend soon then Gold/HUI extremes can't be solved without much higher gold stock prices.


Relative Gold/HUI charts suggest a bottom nearby for gold-stocks and gold.

Eric Hommelberg
The Gold Drivers Report

Email : ehommelberg@golddrivers.com
Web-site : www.golddrivers.com

May 20, 2005

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