The trendline connecting new highs since 2004 (shown in blue on the chart below) is of major technical importance. The time between each successive new high has roughly been 420 trading days. This is a fascinating relationship, and another reason I believe that the high of $1218 made on 12/3/09 is a top that will last for at least year.

It is also interesting to look at relative gold (the orange curve in the chart below). Relative gold is the ratio of the gold price (blue) to its 200 day simple moving average (black), a very useful indicator developed by Adam Hamilton at Zeal to estimate buying opportunities as well as tops. Since the beginning of the gold bull market in 2001 it has been a good rule of thumb to add long positions when price approaches its 200 day moving average, or relative gold approaches 1.0. When the gold price stretches far above its 200 day moving average, and Relative Gold moves above 1.25, it is time to tighten trailing stops and get ready to take profit.

Relative gold made a lower high on each new major high of the gold price since 2004. That could indicate that buying pressure is slowly waning and the gold bull market is losing some momentum. Other momentum indicators like RSI suggest this kind of bearish divergence as well.

I believe that fundamentals are also in favor of a sideways or down move. Golds demand as a hedge against inflation and systemic risk should be balanced by the dollars bull market that started at the same time gold made its $1218 high. The dollar should continue to benefit from deflationary forces due to the ongoing credit contraction and deleveraging, and potentially from another downleg in the equities markets, which I believe is overdue.

Daily Chart:

Spot Gold Daily Chart:

This is a good bearish setup, with very low risk/reward. I exited my long-term GDX positions on Friday for a $12/share loss. My plan is to re-enter on a sustained break of 42.5 or a bounce ahead of the low at 20.

Daily Chart:

COMEX Gold finally broke through $750, and gold stocks are heading into the close with a 15% gain. It is more and more likely that a bottom is now in place at 15.83 for GDX, and more gains over the next few days are likely.

In times when new lows or highs are made, it is always a good idea to look at the long term charts. And compared to the Dow Jones, S&P500, and NASDAQ, the gold stock sector’s long term technical picture is still bullish:

Here we’re looking at a chart of the HUI, the AMEX Gold Bugs Index, which is almost equivalent to GDX, but GDX is a tradable index, while the HUI is not. GDX was only launched in 2006, and we don’t have data going back far enough to determine the long term outlook.

Looking at the HUI chart above, we see that we’ve hit a major long term support trend line, and actually slightly pierced it. There is not a clear break of that trend line yet, and we have to take the extremely high volatility last week into account as well. Extreme fear or greed often cause technical levels to be briefly violated, and that often marks the final top or bottom. I believe we are at such a point now.

As long as this support line is not decisively broken, the gold stock sector’s up trend is still intact. If current support holds this may be one of the best times to go long. Time cycle theory is also in our favor here. We’ve  just completed the second wave in this multi-year bull market of gold and gold stocks. It happens to be almost exactly as long as the first wave that started back in November 2001 and ended in May 2005. Take a look at the similarity of those two waves. Both start with an exponentially accelerating strong upleg to the upper trend line (1), followed by a period of sideways consolidation (2). That is followed by a second upleg ending again at the upper trend line (3) and a final corrective move down to the lower trend line (4). In Wave II, the consolidation phase 2 took much longer than in Wave I, which caused the corrective wave 4 to be shortened and appear a lot more dramatic than in Wave I. But seen within the bullish channel or wedge that is formed by the two trendlines, the two waves are very comparable. Another significant fact is that the highs of Wave I form the bottom of Wave II, which is the 250 level on the HUI chart (25 for GDX).

If these relationships hold, and traders remember gold and gold stocks as safe haven investment again, we may very well see upleg 1 of Wave III starting next week. It would be a powerful and fast swing up towards new highs, hitting the upper trendline in 6 months to a year from now, depending on how fast the first upleg unfolds. This would correspond to HUI levels of 580 to 610 (or about 58 to 61 for GDX). Buying GDX today and riding this next upleg could yield gains of 140%.

Fundamentals for gold continue to be bullish, and the long term technical picture confirms this as well. As soon as the high levels of fear and panic in the general markets subside, traders will return to gold and gold stocks as safe haven investments. We’ve seen an early indication of that on October 8.

I have been waiting for this event to happen ever since the markets started crashing a few days ago. Adam Hamilton at Zeal has written a good essay on this behavior of gold stocks several months ago. He compared the performance of gold stocks and general stocks during bear markets, and the pattern that emerged was that during the beginning of a long decline of the general stock market, gold stocks would first fall as well, but then turn around and decouple from the general market. First, panic grips investors and they dump everything including gold stocks whose share value is closely coupled to the price of gold. But since gold is THE safe haven asset in recessionary times, gold stocks soon move up again as investors search for anything that provides a positive return. There is potential for some very sharp upmoves of the gold stock sector over the next few months as more and more investors reallocate their portfolios.

The daily chart of GDX below also shows a very bullish technical picture. The RSI has formed a triple divergence (each new low was made at a higher RSI value, meaning the bears are slowly losing momentum) and the last low left a Kangaroo tail behind that was tested the next day but the market rejected new lows and went up sharply today. I’m expecting a move back to resistance at 38 over the next few days, as well as more upside for gold, which could test $1000 soon.

Daily Chart:

Daily Chart: