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Gold Stocks and the Head and Shoulders Myth

By Mike Swanson             Printer Friendly Version
July 31, 2006

Gold is poised once again to breakout and go higher. On Thursday, the XAU gapped up to its upper resistance trendline and resistance 144-145 zone. It fell hard on Thursday and then reversed to the upside on Friday.

I responded to the Thursday drop by writing the following about gold stocks on Friday morning:

"If they firm up today or Monday then they will set themselves up for a possible breakout next week. If you notice the resistance and support trendlines are coming together and lining gold stocks up for another big move - which should happen in 5-10 trading days. The most bullish action would be to see the gold stocks go back up and then just sit there for a few days."

This is exactly what appears to be happening. And if it continues, then gold stocks will break out this week or early next week. Frankly, I don't see any reason for them not to break out and rally ahead of this coming Federal Reserve meeting. A close above 144 and the XAU will begin a rally to its 52-week high.

The crazy thing is that everyone is silent about this possibility. It's not just CNBC which has dropped gold from its radar screen, but even gold bugs. But in a way that's understandable because so many got beaten up in the last dip in gold. And when a correction occurs in a bull market, it's not the drop in value of their holdings that disturbs investors, but the mental anguish they go through. They stop seeing the bull market for what it is and start to fear more losses.

They get scared of things that go bump in the night. A few prominent gold bugs are calling for a huge correction and telling people to get out of gold stocks. I know that's hard to believe - just on the cusp of what should be a giant rally they are telling people to exit the market - but that is exactly what is happening. I'm not going to name names, but one big myth being passed around is that gold stocks have a giant bearish head and shoulders formation.

There are a few gold bugs shouting that there is a giant head and shoulders pattern on the XAU and HUI that will end in disaster for people holding on to gold stocks. The problem with this kind of thinking is that even though it looks like a possible head and shoulders, for the pattern to be complete, the XAU would have to make a close below 120.

If the XAU closes above its upper resistance trendline then the possible formation will be negated. In fact, if the XAU were to rally back up to its 52-week high you would actually have a bullish reverse head and shoulders pattern formed - and those lead to incredible bull runs. Let's look at two examples:

Back in the spring of 2002, there were people seeing a bearish head and shoulders pattern on the XAU. The same thing happened last summer. But obviously these patterns never completed themselves. They were simple mirages, projections of psychological fear created by violent corrections in the gold market.

One thing that has kept me very bullish about gold stocks is the fact that so many of them never fell below their 150-day moving average on this last correction. The 150-day moving averages for these stocks are now sloping up. I've never seen this before in previous gold corrections. The last time I saw this was with oil stocks last year. To see what gold stocks are likely to do going forward just look at what the oil stocks did last year.

To find out what gold stocks Swanson is buying now join his free weekly gold report. Start now:


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