10/12/08 7:48 am - GDX: Long term technicals still bullish

It has been quite the roller coaster for gold stocks this past week. On Wednesday, Oct. 8, we declared the bottom based on very strong technical indicators (triple RSI divergence, a tested and confirmed kangaroo tail, and a very strong up day of 14%). The next day, GDX consolidated slightly ahead of resistance at 33, a normal and expected behavior. But then on Friday, it fell victim to a major liquidity crunch when institutional investors suffered margin calls and needed to raise cash fast, and they took it from liquidating stocks across the board, including their newly taken safe haven positions in gold and gold stocks. As a result, GDX lost all its gains, touched 25 for a second time, and closed near the low at 26.34. It did not violate the triple RSI divergence yet (now there’s a potential for a quadruple divergence), but our kangaroo tail may now be replaced by a double bottom if support at 25 holds.

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.