A Bottom for Stocks and a Launching Pad for Gold and Gold Shares.

Charles Cohen

For the past couple months, in spite of the relentlessly chilling headlines, I have believed that the stock market was putting in the final touches of a solid bottom. This would mean that the market was discounting and ignoring, at least for a season, the deeply embedded financial problems and the massive write offs that have accompanied them.

I had two reasons for this assumption. First, the extreme sentiment readings had reached levels coincident with previous tradable lows. In many respects they were nearly identical to those at the lows of late 2002 to early 2003, and more recently in August of last year. These indicators include the AAII (individual investor) and the Investors Intelligence (investment advisor) surveys, a record short interest and very high insider buying.

The other reason has to do with charts or stock price movements. Many of the financial, housing and real estate company shares have rebounded sharply off their lows. But more importantly, amidst all of the public gloom and recession talk, the sectors that signify commodity inflation and increased economic activity such as steel, oil, coal, and the transport carriers have been breaking out into all-time high ground. And finally, two market bellwethers, IBM (technology) and Wal-Mart (consumer spending), have recently risen to their highest levels in over three years. This variety of stock price movements does not point toward an extended slowdown in the economy. Put these all together, and I think it is very likely that stocks will be moving up for the foreseeable future, and as far fetched as it may seem, perhaps even to new all-time highs.

Please don’t ask for a rational explanation in the face of the incredible structural troubles that we face. My guess is that we have shifted into an ultra-inflationary mode where prices on all fronts except for bonds are about to explode.

What does this have to do with gold and gold shares?

Contrary to what we might assume, it is incredibly positive for the precious metals complex! Here is why. Since 2001, gold and the regular stock market have moved both in the same and in opposite directions. But in fact, the correlation has been more often with, rather than against each other, although one day, just as they did in 1971-1974 and at the end of 2001, gold will likely move up dramatically against a very troubled stock market

But if you go back to March of 2003, at the very bottom of stocks and after the gold shares had digested a severe decline beginning in June 2002, you will discover a very surprising correlation: both the HUI and the stock market began to rise at the exact same time.

The following table from 2003 reveals this connection. March 12 marked the approximate bottom of both the Dow and the HUI. Notice that from that date they moved up in tandem, but with one major difference. Over the next nine months, the Dow rose about 40% but the HUI rose almost 120% or 3 times as much.

This relationship is explainable. Since 2002, gold and the stock market have both been affected by both a rise and a decline in liquidity. The gold shares were depressed by the deflationary pressure caused primarily by the pricking of the stock market bubble. After rising sharply from the end of 2001, they crashed in June 2002 and then stayed down until the reflating process started to work through the system. Both the stock market and gold shares then once again moved higher. For example, in the 3 year period from March 2003 Goldcorp rose over 400%. I think all of us would take that return about now.

This brings us up to the current situation. For almost six months, both the stock market and the gold shares have been pressured by the shrinking liquidity directly related to the puncture of the housing bubble. The liquidation has almost brought down the world’s financial system, and has deflated the stock markets of the world. But this contraction has also been sorely felt in the gold sector, and in particular, the juniors and exploration companies.

But from the charts and the sentiment indicators that I look at, a similar period to early 2003 is at hand for both stocks and, more significantly for us, to the gold market. Most likely, the recent panic infusion of liquidity has ushered in a new era, one of ultra-inflation bringing with it an even greater bubble dilemma. And my guess is that this leg in the gold shares will dwarf the one back in 2003, and will finally launch out the depressed and disappointing smaller companies. Many, if not most of these shares that even at $1000 gold have been shunned, will at $1500-2000 become incredibly speculative vehicles. Sounds insane? Perhaps, but is it that so far fetched? If you look at the bottom made by the stock market and the HUI in mid-August 2007, you will see that Goldcorp spiked down from around $28 to $20 in about a month and then more than doubled six months later to an all-time high. That is what I see right now in the juniors and exploration companies. Many of them have spiked down apparently breaking support, but I think that this will be seen as the last panic to get out before they begin their ascent to incredible levels.

MORE EVIDENCE OF A FINAL BOTTOM

Almost every final sell off in the gold shares has been marked by vicious opening gaps and a sense that the gold stocks would never rise again. Well, if you can look closely at this latest drop over the past couple of weeks, you will see this pattern reappearing. Goldcorp once again has had 3 major unfilled gaps down over the past 6 days. It has been even worse with many of the juniors. Gold has risen nearly 400% over the past 7 years. That is a very impressive length of time and price appreciation. But except for a couple of brief spurts, there has never been a real bout of speculation. And the history of markets have taught us that an extended bull market will never conclude until there is at least one extended speculative phase accompanied with a strong public participation. This historic gold bull market will not end until the greatest period of speculation in the history of financial markets has been seen.

Armageddon is still on its way, but it has been temporarily placed on hold. One day, the ultimate crisis will not be easily solved by massive injections of liquidity as this one has. But in the meanwhile, we should have quite a wild ride in the precious metals, and specifically in the shares. Chuck ikiecohen@msn.com