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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Gold at $1,000 and Beyond

Commodities / Gold & Silver 2009 Sep 08, 2009 - 06:02 AM GMT

By: Michael_Swanson


Best Financial Markets Analysis ArticleGold is clearly headed to 1000 an ounce now. Last week we saw a key breakout in both gold and gold stocks, with many gold stocks up over 15% in just the past two trading sessions. The HUI and XAU both closed at new highs for the year last week too. This is key, because normally the trend in gold stocks leads the metal - meaning when gold stocks outperform the metal and go up faster than the metal it is bullish for both.

For disclosure purposes I am long gold stocks. I started to buy them and recommend them to my premium subscribers on August 28th.

The 1000 mark has held gold prices down for almost two full years and causes gold to trade in a range of 700 to 1000. Of course that range has been narrowing for the past few months with 900 marking the low of this summer.

When a level such as 1000 acts as long-term resistance for this long it can lead to a new massive up leg once it is broken - a new secular move that can last for months and even sometimes years.

The last time it spent this long below a long-term resistance level was from the first quarter of 2006 to the end of 2007 when 700 acted as huge resistance. Once it finally clearly 700 for good gold rallied over 42%.

Before that the previous big bull run in gold happened in 2005 when gold rallied from 450 to about 750 for a 66% gain.

Once gold clears the 1000 mark and stays above it for a few days then in a few months it will be setup to rally into the 1300-1700 area - perhaps even more.

The move last week was so powerful with big volume that it pretty much appears inevitable that gold is going to take out the 1000 level. Don't forget too that seasonally gold tends to have its best months from September to January.

To me last week is a really huge and important week for both gold and the stock market. Last month a lot of people came out of the woodwork to argue for a Fall stock market crash and a collapse in gold prices. The most prominent of these people were the Elliott Wavers who got some mention on CNBC for claiming that the stock market has to have peaked at this level, because they believe that the stock market peaks and bottoms at exact points that they claim to be able to predict with "wave counts" and "fibonacci sequeneces."

When a market hits their targets then they assume it must reverse, because it "has to" in their mind in order for their theories to be valid.

They also believe in deflation, because they believe that commodities are going to fall to their predicted levels and that the dollar has put on a bottom. They predict oil going to $20 a barrel so therefore whenever oil or other commodities go up they think they are bear rallies in a bigger "wave structure" based on the number pi.

What I never understand though and always ask this of Elliott Wave believers and have never gotten an answer is this - why in the world would the stock market trade in some sort of exact mathematical fibonacci sequence? As I wrote the other week, "This is more a religion than science. The presuppositions that lay behind wave counts is they claim that all of nature is based on fibonacci numbers. If that were true then it would mean that all of human history - and the future- is predetermined by some math sequence. It would mean you have no free will, because your own behavior must match these numbers. Of course that is ludicrous. I know that the next time I eat, sleep, or go to the bathroom is not going to be predetermined by a fibonacci sequence so I put zero stock in those theories and many of the people espousing them."

If this doesn't sound convoluted to you than you understand these things better than I do.

If the Elliott Wave believers are right about all of this though then we should have seen gold and gold stocks break down last week. We should also have seen more selling happen in the broad market.

But neither of these things happened. The broad market firmed up and gold and gold stocks exploded to the upside.

I think last week was not just bullish for gold, but for the broad market too.

I've been saying this is a bull market since July and continue to think it is a bull market. What happened in July to make me bullish was the fact that most of the sectors that make up the stock market began bull markets of their own by ending months of consolidation and breaking out above their long-term 150 and 200-day moving averages while the advance/decline line began to rally ahead of the stock market averages - meaning that the average stock was actually going up faster than the S&P 500 stock index.

That was a sign that the rally had broadened from being fueled by short covering to broad based buying. That's the the type of thing that starts near the beginning of a cyclical bull market.

To me this is a huge complete difference from what happened this time a year ago. A year ago the markets had just put on a bear market rally that lasted from March to May. The broad market averages then went sideways through the summer and rolled over in September as they headed into the Fall wipeout.

Gold and gold stocks had a false break upwards in August and then reversed and broke through their major support levels ahead of the rest of the market.

I remember this clearly, because I was in Las Vegas at a gold investment conference. I had been bearish on the broad stock market, actually being short at the time, but I thought gold had a chance to go higher in the Fall. But when it broke down I took that as a sign that some huge changes were happening in the stock market - ones for the bad.

Now we are in the complete opposite situation. Gold and gold stocks just broke to the upside while the stock market just had a short-term correction in a larger cyclical bull market. Instead of being worried about what the future holds for stocks as I was exactly a year from now, we can now look with hope at the potential returns ahead of us.

It isn't always clear what is happening in the stock market, especially when the market is at key turning points. In the end you have to watch the market trends and adjust yourself accordingly when it becomes clear that they have changed even when it goes against your expectations and assumptions.

A year ago I was very bearish on the stock market - actually being short much of the time - and I thought the economy was going to be in big trouble. In the summer it became clear that serious banking problems were going to hit the market in the Fall. There were articles explaining why and when Fannie Mae were going to go broke before they did. You could have studied this information months before they impacted the stock market and been able to position yourself accordingly. I know you could have, because I did.

I did that by going short the broad market averages and by buying gold stocks. I thought gold stocks would go up when these banks got in trouble, because the US government and Fed would bail them out by printing money. This indeed happened, but gold stocks went down with everything else as hedge funds and institutional investors had to sell everything off to meet redemptions in massive deleveraging.

I wasn't expecting that in August 2008, but when gold broke down I got stopped out of my gold stock positions and realized that this is what was indeed happening. Now gold is acting contrary to some people's expectations and they better react to that or they will be punished.

Gold provokes strong reactions in many people and one debate that has been going on for the past year is whether we are headed for deflation due to continued economic weakness and credit contraction or inflation due to the Fed's money printing and government deficit spending.

In the last quarter of 2008 there were clear deflationary trends in producer and consumer prices following the huge drop in oil, commodities, and consumer demand as the US economy contracted over 6% in a single quarter.

But the deflation slowed down earlier this year and has slowly reversed, with inflation picking up as the GDP swung into positive territory in the last quarter. Economic growth should continue to be weak, but we should have seen the depth of overall weakness earlier this year.

Hardcore deflationists argue that this is just a blip in a much longer deflationary trend that is going to break out in full force this Fall in another stock market collapse. The Elliott Wavers believe in deflation, because they have all of these wild projections for super low commodity prices that haven't come true yet.

The move in gold right now should force many of those that are stuck believing in deflation to revaluate their beliefs. Those that stuck to the belief that the Fed can solve everything or you always hold stocks last year lost money. Those that stick to a belief in deflation in the face of rising gold prices may similarly lose money or miss out on investment opportunities going forward.

For a few months last year I personally considered the possibility that deflation was going to be a new trend. There are some solid economic arguments for it if you read Murray Rothbard's book America's Great Depression, which explains why deflation took hold in the 1930's. There are some similarities to what happened back then as compared to today, but also many differences.

The problem is that most of the really hardcore deflationists aren't grounded in real economics, but in very esoteric theories that have very little scientific basis to them and are not accepted at all by the mainstream. It is almost like a religion for these people. I guess believing in fibonacci sequences is a type of modern day religion or investment cult.

But in the end if you want to make money in the stock market you cannot stick with some rigid thought system. All investors face the challenge of having to accept the reality that the market is telling them they are wrong at some point. If you have been in the stock market long enough I'm sure you made the mistake of just sticking to some view while the market kept going against you at some point. I know I have. Everyone has. When the market first went up I thought it was a bear market rally, but eventually I caught on. The trick is minimize such mistakes as much as possible.

And right now gold is going up. Gold is heading to 1000 and beyond. The question is what does that mean to you and should you do anything about it?

Don't ever chase anything if you want to go long. Gold and gold stocks made a tremendous move last week. They may go straight up from here, but what is more important than catching a move in a market or class of stocks is to only take an investment position with a game plan that includes an evaluation of the amount of money you are willing to risk and an analysis of the potential return you can expect.

Just buying, because you see something moving isn't enough to meet this criteria. If you buy gold stocks you need to know where you are going to get out if you are wrong. You need to know where you will place a stop loss order. If you can't do that in a comfortable area, because it already has gone up so much then you are best to be patient and wait for a period of consolidation or a pullback to take an entry point.

Now if you are short and bearish and believe that gold has to top at 1000 because your wave count says so or for other reasons that we are facing deflation and this is a final fake out then still you need to have a stop loss order for your short positions in case you are wrong.

If you are short and refuse to do that then all I can say is I'm going to pray for you.

This article is an excerpt of a premium WallStreetWindow members articles. It continues here with a discussion of the stock market and individual stocks.

By Michael Swanson

Mike Swanson is the founder and chief editor of WallStreetWindow. He began investing and trading in 1997 and achieved a return in excess of 800% from 1997 to 2001. In 2002 he won second place in the 2002 Robbins Trading Contest and ran a hedge fund from 2003 to 2006 that generated a return of over 78% for its investors during that time frame. In 2005 out of 3,621 hedge funds tracked by HedgeFund.Net only 35 other funds had a better return that year. Mike holds a Masters Degree in history from the University of Virginia and has a knowledge of the history and political economy of the United States and the world financial markets. Besides writing about financial matters he is also working on a history of the state of Virginia. To subscribe to his free stock market newsletter click here .

Copyright © 2009 Michael Swanson - All Rights Reserved.

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