Second phase of the gold bull, or parabolic blow off top?

Jack Chan
www.simplyprofits.org
Nov 26, 2009

We had an excellent entry point on the gold stock ETFs in August, and our positions are deep in profits. However, our allocation was too modest, and there have not been any decent set ups to add to positions. Many members are asking what my upside projection is, and whether they should just jump in.

Gold has no overhead resistance, therefore, any projections are pure guesses.

What I do know, is, if gold is now in a second phase of a bull market, then a multi month consolidation could start anytime, and our better buying opportunity will come in 2010.

If the parabolic rise continues, then this is more like a blow off top similar to what we saw in 1979/1980, and we all know what happened when that party was over.

Let's take a look at the two possible scenarios.

#1 - Second phase of the gold bull

Since the gold bull began in 2001, shortly after each and every time when gold made a new recovery high, prices began a multi month consolidation before a new leg started again.

A six month consolidation took place in 2002 after reaching a new recovery high of $330.

Also a six month consolidation in 2003.

A four month consolidation in 2004.

An eight month consolidation in 2005.

Another six month consolidation in 2006.

Also a six month consolidation in 2007.

Observation

The first phase of the gold bull market from 2001 to 2007 was very orderly. Each and every year, gold prices spent at least half of the time on average consolidating before a new leg up. Gold stocks followed this same pattern. This gave us plenty of opportunity with set ups to enter the market as some of you may recall.

Therefore, unless this time is different, and unless we are in the middle of a blow off top similar to 1979/1980, prices should soon fall sharply and go sideways at least a few months before the next leg up.

How about gold stocks now?

Gold stocks are lagging gold prices, but should not be a major concern if we are indeed at the beginning of phase two. $HUI can rally another few % to reach resistance, and if gold prices consolidate, we will have a potential "cup & handle" pattern in the $HUI. The "handle" will be similar to the consolidation in gold prices and the bottom of the handle should not be more than 20% from the top.

Silver has more to go before reaching the "rim" of the cup.

GDX is only a few % away from resistance. Our core position should be safe if a cup & handle pattern is in progress, but for money management, I may consider a hedge.

XGD.TO is almost at resistance. Like GDX, I may also consider a hedge to protect profits.

NEM is already at resistance.

Observation

From a technical analysis point of view, both gold and gold stock prices have a bit further to go, but should begin a multi month consolidation soon, if we are indeed at the beginning of phase two of a gold bull market.

#2 - a blow off top similar to 1979/1980

I am not forecasting as such, but we need to be on guard because such a blow off top will not be kind to gold investors, especially those who are late to the party.

Gold went parabolic in 1979 after breaking out, and it went from 200 to 800 within a few months. But the crash was equally spectacular as prices dropped nearly a half within weeks and then gold gave up almost all of its gains by 1982. What followed was a painful twenty year bear market which most gold bugs would rather forget.

If we are now indeed in the middle of a blow off top, then we have seen nothing yet. It will not surprise me to see gold around $3000 to $4000 with the next few months, and very few will be able to exit anywhere near the top. This is not a forecast, but a common sense scenario.

Summary

Being under invested in 2008 was great.

Being under invested in 2009 sucks.

Watching gold prices making new highs everyday is testing my patience and discipline. Like some analysts have suggested, just buy gold at all cost....

...NOT.

I do not buy anything at all cost. [Editor's note: highlighting is mine]

If gold and gold stocks are at the beginning of a second phase of a bull market, we should see many more years of upside and countless opportunities to increase our wealth over time.

A bull market is not an event, it is an ongoing process.

A bull market spends at least half of its time consolidating previous gains, thus allowing us to accumulate positions.

The only time prices truly run away is when we have a parabolic blow off top, like gold in 79/80, and Nasdaq in 1999/2000. These blow off tops are very cruel to investors as many do not have an exit strategy. Gold went on to a twenty year bear market, and Nasdaq is now in its 10th year since the collapse and it is still 60% off from the top.

From what I can see currently, I do not see a blow off top in progress in gold prices. In fact, I am not certain that phase two has even begun until gold stocks make a new high, and begin to outperform gold consistently. Therefore, my expectation is that a multi month consolidation can start anytime, and a better time to buy will be some time in 2010.

End of report

Nov 26, 2009
Jack Chan