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Must Read - Part 2

By Neil Charnock      Printer Friendly Version
Aug 11 2008 11:56AM

www.goldoz.com.au

This article looks at the most undervalued market for gold shares that I have ever seen – and that statement encompasses the 2000 bottom which was before the gold bull had begun. Capitulation rules the day – however it is like watching an elastic band being stretched beyond its limit and waiting for something to either snap or rebound violently. A great deal of current analysis is offered in this article and will be expanded on in our Members area next week.

There is also no doubt that difficult credit conditions and low share prices have falsely put the Australian gold mining industry in a more difficult position than it should be.

From an investment point of view – this is a bonanza. This is a chance to virtually “steal” gold shares at or below bargain basement levels. Sentiment is a great indicator to me and is currently about as low as it could get. Most of us multi year gold watchers imagined that gold stocks would be would be in a tremendous rally by now – once the 1980 peak at $850 had been reached and breached. This technical level is so old however that it has little significance in terms of 2008 deflated dollar terms or in the memories of the public.

Our local market analysis

We have developed a new leading producer PDF format that includes charts and technicals – and loads of essential links. This helps us and investors to keep tabs on the opportunity at hand and I am happy to share some insight in this article. Larger gold producer charts mainly have falling wedge patterns - are at key support levels or are showing signs of divergence. These divergence patterns can continue or break down of course so we need confirmation that the turn is in evidence before we deploy investment capital – we monitor the situation closely. There are three inverse head and shoulder patterns and a handful of – “non-descript” technical patterns amongst the stocks we cover.

The market remains dangerous with two break downs below falling wedge support recently – one on capital raising fears at a point where this company is in the position of being able to dramatically increase production after a period of infrastructure constraint. Potential good news on the capital raising front – which considering the resource and sound position of this company - would result in a share price turn around and highlight the current price level as an exceptional bargain.

On this note also – I have read about a number of successful capital raisings lately which proves the show is going on… or at least the mining show down at the “coal face” continues. The mining companies are operating, many of them profitably, at these commodity price levels despite the picture painted by descending share prices. One lonely break up so far – on go ahead news for exciting major mine expansion which will also cut production costs for that company.

One has to consider that the unrealistic levels now being reached are the result of hedge fund activities in conjunction with low sentiment induced by fear. Fear is the opposite of greed and it should be pointed out that times of fear are the time to buy – times of greed are the times to sell. However even better – when you see price dislocation between related asset classes and the market is wrong footed – you have potential percentage leverage returns not usually seen outside the derivatives markets.

Aussie dollar & currency considerations

For offshore investors the Aussie Dollar and exchange rates have to be a consideration. The Australian currency has fallen to an oversold level against the USD on a daily basis however not on a weekly basis. After reaching a high of 98.5c to the USD (July 15th) the Aussie dollar has since fallen to close today at $0.8929 - which is the sharpest fall since August 2007. We have broken an untidy rising wedge pattern now and could ultimately fall as low as the 80c area over time – for now we look to be getting oversold though on the daily chart. I do not know if the 80c level is possible but that is the base support at this stage.

The point is that this AUD drop has minimized the fall in the price of gold in terms of the Aussie Dollar to $AUD 965.42 as I write. Silver now trades at $AUD 17.16 as I write.

The Euro: AUD had diverged during May this year around the 1.63 level, formed a consolidation pattern with support at 1.62 and has now moved to the upside with the fall in the AUD fortunes. We are at some strong resistance at the 1.69 – 1.70’s level which must now be overcome if is to break which I doubt. This is an upper to mid range valuation over a 5 year time span.

The pound has moved up on the AUD after some very obvious divergence. This is a statistical low compared to the AUD over the last 5 years and I expect the Pound to continue to strengthen against the AUD.

Euro support of Australian miners should not be greatly affected by these movements as the average shows our currencies move more in tandem – or have done for several years and unless this pattern is broken I will hold this view. The pound and USD holders however may have been waiting – holding off for stronger levels in their respective currencies. When this arrives in conjunction with stronger gold prices it will get explosive here in our comparatively small precious metals mining sector.

The USD: Euro is interesting – massive consolidation at a new high plateau shows a sell divergence on the weekly chart. Are we in for troubles with the Euro next as the USD rebounds? I will be watching this ratio with interest because it could result in a strong investor exodus from the Euro region into Australian gold mining. Equities have to gain some traction for this to occur – at least PM mining equities which always have the potential to diverge from other weaker market sectors. An associate pointed out that gold moves up with strong economies if other factors are in place – it’s called demand.

The currency trend at present is ideal for the gold sector on the ASX. Falling AUD means the correction in the gold price is muted – falling USD gold and falling AUD in tandem.

Global stock markets & current picture of resource demand

From our bias we look to the demand economies – commodity demand.  So eyes are on Shanghai and the USA – technically speaking the Shanghai Composite Index is mapping out a base formation with strong RSI to price divergence. Overhead we have to break 3000 and underneath we eye the current levels for key support and the potential price / RSI divergence patterns now forming. Increasing domestic demand and infrastructure roll out are expected to maintain robust growth - and support firm to strong commodity prices for years to come yet.

The fact remains however that some metal prices have cooled which was needed and is a positive for the ongoing robust growth – at a reduced rate which is more sustainable. It also helps slow the rise in the AUD as exports fall in value. Commodity demand was over estimated and will now be underestimated – curious thing that – greed and fear again.

The Middle East construction boom continues with the “petro dollars” driving the show on. The IMF still predicts Brazil will grow by 4.2% for 2008. India is tipped to grow by 8.1% down from an earlier forecast of 8.5%, still a very credible growth rate and still resource, and potentially gold hungry.

The Japanese market diverged back in the mid January to mid March period and then rallied only to settle back into a short term consolidation pattern this last three weeks. There is another shorter term divergence forming now and a potential right shoulder of an inverse head and shoulder formation. Confirmation will appear shortly or not – weekly MACD is neutral to slightly positive. After I wrote this we may have that confirmation with a break out just today.

KOSPI Korea – market bounced off major supports last month after multiple short term divergences and now shows signs of a strong divergence – potential rally to be confirmed by an up-leg through a down sloping resistance. Same applies to Germany, the CAC40 (France) and the FTSE.  The Dow and broader S&P 500 both follow (or is that lead) a similar pattern. If I am wrong and we happen to go through supports here we could see the 1150 area for the S&P 500 and the 10,000 level for the Dow tested and further breaks down in other global markets.

I would not suggest the global financial system has been sorted, not for a moment however I would like to point out the power and resilience of the Global Central Banking System – a power that has enabled them to pull off a remarkable Fiat game for almost 37 years and a period of global growth and relative prosperity for the planet as a whole.

So my warning to the doom and gloom crowd is that there just might be a turn around in global equity markets and maybe even the USD for a time. Backed by an understanding of the inflation adjusted value of the global markets – I would also like to point out that the falls have been far more severe than the numbers suggest.

Inflation adjusted terms

The fight to save banks and certain institutions from fallout resulting from a “zero risk mentality” of the past several years has created a flush of liquidity and new money. Figures put this as high as 16% per annum and I do not doubt that. This is not isolated in the recent past - at a continuing rate of increase at this magnitude we see these markets devaluing faster in inflation adjusted terms.

This is a concept well understood by gold bugs to define the inflation adjusted highs needed to duplicate the 1980 highs in the gold price. But what about the share prices – a sideways move - is in real terms - a drop in value of at least 5% over one year at 5% annual inflation. A fall of 20% is really an adjusted fall of 25%. Let’s take a look at the Dow in these terms.

The Dow fell from 11500 in 1999 / 2000 to 7200 three years later at the end of 2002. This was a fall of over 37% however it took three years of inflation and time to complete that down leg. We must adjust for a minimum (low ball) inflation of 10% over this three year period – meaning the 11500 would have had to go up by 10% to 12650 just to break even. 7200 was a more serious fall than it looked at that time.

Move forward to the end of 2007 – a full seven years after that initial peak of 11500. Allowing for just 4% compound inflation per annum - you would need to have reached a new high of 15133 to break even and reach an adjusted equal high. At a 16% per annum adjustment the numbers would get startling however we will not go there for now as I do not like to appear extreme. Any way my point is that the second top reached at the end of last year of 14200 was not even close to an equal high in adjusted terms.

The low reached at the end of 2002 was about 7200 which in adjusted terms would be equal to approximately 9000 in current terms at a 4% compound rate. If we allow for the true rate of new cash coming into being over this time… what is that?? At 5% which is still low ball considering the massive increase in monetary growth we have seen – we would see an inflation adjusted low of 9550 instead of the 7200 reached at the end of 2002.

At 6% we would only need to fall to about 10,000 to reach the equivalent lows of 7200. By many standards we have measured 10% monetary growth and this equates to an inflation adjusted low of 12,384 which looks more like overhead resistance than an adjusted low.

We have recently fallen to new lows on the Dow in inflation adjusted terms by this definition – technically we are now at an interesting point. There is strong support here at the 10800 to 11600 area corresponding to the old unadjusted highs of 1999 to early 2002. The end July 08 short term high at 11700 came back to resistance of the lows set in January and March this year. This has just been broken however not decisively as yet. Seasonally we have a strong chance of a gold rally – the global stock markets point to this possibility also. We watch and wait – there are very large capital reserves on the sidelines waiting for confirmation, so I am not alone.

Conclusions:

  • AUD is at a good point short term – oversold & maybe a deeper low to follow to the USD. AUD in Euro is currently mildly high – potential Euro break down. Probability is that the Pound will rebound further against the AUD.

  • Global equity markets – could rebound from here, yes even the Dow and S&P500.

  • Aussie gold and mining stocks are forming bullish base and falling wedge patterns but confirmation is needed – suspected correlation to global equity markets needed for the rebound to begin.

  • Aussie gold and other PM equities at stupid valuations – super low.

  • Base metals and diversified miners need to be driven by continued resource demand – a likely event but at a slower rate. This is very positive for gold miners and gold which is due for upside.

  • Danger still lurks and fear is prominent – fear is the correct time to buy however Caveat Emptor (buyer beware) – consider your risk aversion.

  • More on the gold price fractal pattern analysis coming in a later report out soon or on a preview at our web site.

Good trading / investing.

Regards,

Neil Charnock

 

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Neil Charnock is not a registered investment advisor. He is a private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.