-- Posted Sunday, 12 March 2006 | Digg This Article
What a week!! A gold share sell off so typical of the Elliott final collapse wave in a classic a-b-c correction. But this is NOT the end of the run. It is merely the second correction since the market low in June 2005. It is the 3-4 move out of the five wave format and there is still the substantial fifth wave upside leg to come. In addition the gold index has mapped out a classic flag pattern that is a BULLISH pattern. So all is not lost. It is just the end of a sharp correction.
I must reiterate that I have continually detailed that wave I of the JSE Gold index topped out in 2002 and corrected in wave II to May 2005 to give the first major I-II correction. In May 2002 it reversed into the big wave III that MUST go well above the top of wave I in 2002. The corrective wave of this week was merely the final sell off in a correction en route to the top of wave III. It was not the end of the bull market.
But the interesting aspect of the recent correction is the shapes that have formed during its progress. The full correction has traded inside a classic flag pattern of two parallel channel lines. But in addition there are flat top broadening patterns coupled with falling wedges. All these patterns are BULLISH and point to a very sharp trend reversal back into a new bull phase. In other words it is time to load up with gold shares for a major ride.
For the past few months I have been detailing that the Rand should weaken back to around R6.35. It remained churning around the R6.05 level and never looked like breaking. Suddenly last week it shot up to R6.35. Where to now? There remains the potential for further short term weakness to R6.50.
I have had to spend some time researching gold production and relationships to price movement for several presentations on the gold market. There are some surprising statistics in this data that throw considerable light on the movement of gold shares on the JSE over the past few years.
The fundamentals remain rock solid for a large move in the gold price based on falling global production combined with sharply rising Far East demand in addition to an increasing distrust of the dollar as an investment currency. Sure the gold market is going to have sharp corrections. It is the nature of the yellow metal to move from buying euphoria into selling stupidity in a matter of days. Traditionally it keeps you hanging on by your finger nails before it changes course. But it does not matter. We are into the big wave III that must go above the tops of wave I in 2002. So that any short term sharp correction is just another superb buying area, not a panic selling one.
The sell off hit all the commodities based on a sudden rise in interest rates in the US that theoretically should strengthen the dollar. I have news for you. Technically, interest rates in the US will certainly rise but the bullish effect on the dollar will be negligible. Rising interest rates implies falling bond and equity markets as well as inflation. But the problem will arise in terms of Japanese and Chinese investment in bonds. Will they be happy to see their US investment capital eroded??
At this point of time all the commodities have been doing the same intermediate correction in an ongoing bull market. So it is also buying time for oil and other metals as well as the precious metal sector, as well as the shares in these commodities.
Global gold shares are a superb buy whilst the other general equities continue to machinate in sideways moves.
I must reiterate for the doubters that we are looking at a major long term bull market in gold with the current level being a superb short term and investment buying opportunity.
Elliott bull trends moves in five waves. There are corrections at 1-2 and 3-4 before the final fifth wave into the top of the bull trend.
Often wave 3 can be longer than the rest and also sub divide into five smaller waves as detailed by the blue numbers.
But there are two key points to note. First the correction from 3 to 4 will be larger than any of the blue sub-wave corrections and it will wipe out the whole of the last move in the blue five wave format. Also note that there is often a channel formation in wave 3 shown in red.
Apply this to Harmony, and all the other gold shares, there is a perfect fit.
The wave 3 sub-divided into a smaller channel and wave 4 has wiped out the whole of the fifth wave inside this sub division. The RSI reflects the Elliott breakdown of the wave pattern.
Note that the RSI during the recent price fall has moved below its previous lows but that the price has not confirmed. This is a classic example of a reverse divergence trend reversal back into a bull trend. In addition Harmony has mapped out a falling wedge formation that implies a very sharp trend reversal. The bottom line is that we are at the end of wave 4 and ready for a move back into a major bull trend to take Harmony up into wave five.
In addition I have shown the bottom of the huge wave II in May 2005. The next upside move MUST take the price of the gold shares and the JSE Gold index well above the top of wave I in 2002. There is a lot further upside to come in this gold market.
Also note that the recent high on Harmony made at the end of January was also reflected on the RSI as it also went through to a new high. This signifies a stable bull trend and there is no sign of any sell divergence.
This remains a major BULL Market in gold stocks and corrections such as last week are ideal buying areas for traders and investors alike.
Global gold production is the feint red line. There is a clear cyclical movement to this chart in which a 20 year increase is followed by a 10 year fall. The last production increase ended in 2002. The 1930’s increase was due to labour costs falling during the depression and mines producing more gold at a fixed price. Again in the 1950’s there was an increase in production due to the fixed price at $35 forcing the mines to produce more gold to make profits. Since then there has been a totally different story that is told when we apply the dollar gold price to this chart.
The annual global gold production rocketed from 1200 metric tonnes in 1980 to 2600 metric tonnes in 2000.
But the interesting aspect of this data is the relationship between the gold production in the top chart and the gold price in the bottom frame. Once Nixon had freed up the gold market the price rose to its 1980 peak of $850. During this period gold production fell. There is a very good reason for this. During periods of price rises the mines tend to develop the lower grade areas and leave the higher grades for times of price weakness. When the price collapsed from $850 to $252 there was a huge doubling of production. But despite this production increase the relative earnings of the mines halved during this period as the fall in price wiped out the extra production. Since the price rise from $252 there has been a reversal to falling production. So apart from the established 20 year boom bust production cycle there is also an inverse relationship between the gold price and production. This implies falling production going forward.
The most bullish fundamental for gold must be the accelerating demand from the Far East where jewelry from India and investment demand from Japan and China are growing at an exponential rate. The economic growth of China at 9% per annum is projected to remain well above 8% for the next decade. But this is not the key figure. Gold is consumed by a growing middle class and my professional analysis indicates that Chinese society is expanding at greater than 20% per annum. China is the world’s largest consumer of meat, oil seeds, fruit, vegetables and rice as well as being the largest producer and consumer of lead, tin and zinc, in addition to the largest metal consumer of steel, aluminium, nickel, copper and also rubber, cotton, wool, and cement.
The enormous size of this market is highlighted when one realizes that there are more cell phones in China than the population in the US. Three years ago China freed trading in gold and the Shanghai Gold Exchange is into boom times. Couple this with the fact that China has increased its gold reserves from 350 tonnes to 600 tonnes whilst the UK has halved. There are already internal political rumblings for China to substantially increase its reserves in order to protect against any demise of the dollar. A global scenario is developing in which there is a growing demand coupled with a potential for falling production.
According to the reports of leading industrialists that have plants in China they ship 65% of production back to the US. By 2012 this will have reversed with China consuming 65% of their production and by 2015 china will be totally self sufficient. China will not have to rely on exports going forward to sustain growth.
Forget the economics. This is a numbers game.
When falling production, growing demand, increasing distrust of the dollar and gold outperforming equities is considered there is a considerably bullish outlook for gold.
This is all well and good for global gold prospects but what about the local South African situation? In contrast to the 1980 to 2000 boom in global gold production South Africa’s production fell from 680 000 kilos to 320 000 kilos. Combining this huge fall in production with a dollar gold price drop from $850 to $252 over the same period should have resulted in all the local gold mines closing. They didn’t, primarily due to a weak currency that quadrupled the Rand price of gold.
The devastating period was from 2002 to 2005 when production continued to fall coupled to a serious fall in the Rand price of gold. This led to a panic in the press as they queued up to knock the mines in early 2005 on the basis that they were all going to close. Suddenly the price reversed and is back up to its previous high ground and according to my work likely to move much higher than the current R3500 an ounce.
Even so the current Rand price of gold has only resulted in just above breakeven conditions. For the local gold industry to prosper a significant further appreciation in the Rand price of gold is required. My data indicates that the Rand price of gold should continue to rise well above its previous R3800 an ounce high in 2001 and probably to at least R5 400 per ounce within the next few years based on a rising dollar price of gold and stable to weaker Rand. This would give a relative value of R175 000 a kilo. Considering that the gold mining industry is at least breaking even at the current Rand value of R105 000 a kilo such a five year price bonanza would lead, after adjusting for costs, to a significant increase in not only mine earnings but also a nominal increase in local mining production.
Apart from the short corrective periods the gold price has outperformed all leading global equity markets since 2000 as well as out performing all the leading currencies including the investment stalwart Swiss Franc. This clearly shows a trend away from equities as an automatic investment as well as a growing distrust of both the dollar and Swiss franc as investment currencies. A decade ago it was a knee jerk reaction to fly into the dollar in time of Middle Eastern crisis. Not any more.
Couple rising demand with falling production and sweeten it with a distrust of the dollar as an investment currency and the fact that bullion is outperforming all the leading equity markets and you have prime conditions for a continued long term gold bull market.
I have updated my long term Elliott analysis of the gold price. I was looking for the minor 7-8 correction prior to moving up to final wave 9 above the $625 area. This should lead to the larger 7-8 correction. The current gold price correction is a weak reaction as the second low has failed to move under the first low. This implies a strong forward move after this correction has ended.
It would not surprise me to see the final wave 9 split up into five sub-waves with moves to $585, then $625 and finally $685. But this remains to be seen. At this stage I will stick to me long term $625 target area.
At this point of time there are no sell divergences on the shorter term chart and I expect to see further upside potential going forward.
