“11:59”

Over the last 10 to 12 days, we were watching the Gold market intently. Noting steady deterioration in Relative Strength and a series of new highs in Gold, non-confirmed by the Gold Stocks, we continued to wait. We held out as long as we dared before moving toward a sell signal exiting in two stages. I held back beyond the point where I was comfortable and to the point where I was very concerned that the market might see a serious break and there wouldn’t be time for people to get out. In my view, I can honestly say that I held back to the 11^th hour, and for me, beyond the 11th hour. It was 11:59 on the technical clock when I gave my sell signal.

Unfortunately, I should have waited a minute more, or in this case, a day more, as holding out just a shade longer would have earned us an even greater return. Frustrating, … you bet. Such are the draw backs on occasion of a market timing approach. Yet, we earned good money over the last 6 months, returning over 28% in cumulative profits, on two separate trades, with the final round yielding returns just over 20%. However, you cannot catch ‘em all and selling the exact top is never an easy trade. Yet as frustrating as it was over the last two days to sell the gold stocks and then watch the XAU move rapidly above 120.00, I continue to believe that my decision to exit the market was well founded and based on sound logic and a set of indicators, which continue to suggest an important medium term high is at hand.

Of course, time will tell whether our exit was indeed reasonable or entirely off the mark. For my part, I will pledge to continue to be open minded and if it appears my bearish call on the Gold Stocks is going to be incorrect (for any meaningful period of time), I will definitely attempt to reverse course and re-enter the market. Becoming a stopped clock is the one mistake a timer cannot make.

I AM A GOLD BULL

Looking ahead at the bigger picture, I remain a Gold Bull and definitely believe that both Gold and Gold Stocks have much higher to go over the next several years. That said, at the moment, I strongly believe that the upward thrust of the last two days is a final ‘run for the roses’ capping off in climactic fashion, the medium term advance seen at the May 13^th bottom, over 6 months ago.

... But a Correction is Coming
From here, in my view, the overpowering weight of the technical evidence argues for a 15% to 20%, two to three-month correction in the Gold Stocks and an approximately 8% decline in Gold Bullion. In all likelihood, this correction will last into early February 2006. In my work, it is important to set benchmarks and parameters and to that end, if this is not going to be an important medium term top, we should know that within the next 10 to 12 days… and at that point, I could begin finding my way back into the market, if it appears I acted in haste. For now, I seriously doubt that will occur. While there is no doubt that my exit from Gold Stocks was a bit early, I am nevertheless, 99% confident that a sizeable correction in Gold and Gold Stocks lies directly ahead and that within the very near term, prices for both Gold and the XAU will reverse and give back all of their recent gains and then some.

LET'S START WITH A REVIEW OF THE INDICATORS

Why do I feel the way I do? First off, I want to start the analysis with a review of the Relative Strength Gauges, which had me deeply concerned about the near-term prospects for Gold and Gold Stocks earlier this week. As can be seen in the chart below, going back over the last two years, the Gold Stocks have made a significant medium-term high late in the year, once in December 2003, and then in late November 2004. During each of those peaks, we saw the Gold Stocks as measured by either the HUI (Amex Gold Bugs Index) or XAU (Philly Gold and Silver) failing to keep up with the movement of Gold Bullion in the very late stages of the advance.

Combined HUI & XAU with Relative Strength vs. Bullion Price
In the chart below, I show a composite Gold Stock Index, which is simply the HUI and XAU combined on the top clip, and the Relative Strength Ratio of the stocks versus Bullion on the bottom clip. Note that in both prior topping instances, higher price highs in the Gold Stock Indices were met with lower readings on Relative Strength Ratio and rather swiftly led to major medium-term declines.

What’s more, despite the rally of the last two days to new higher highs in the Gold Indices, the Relative Strength Ratio is still failing to confirm as the stocks have only managed to keep pace with Bullion. In order for the R/S Line to improve (rise), the stocks need to be outperforming bullion, which they have not. When we first started watching this last week, I noted on Wednesday November 30^th, 

“that since the close of Monday, November 21^st, the XAU is down from a reading of 117.96 to a current reading of 114.58, for a loss of 3.38 index points, or 2.86%. Obviously, a great deal of that loss came today with the XAU falling 2.88 index points or 2.45%. In contrast, the price of Gold is still up over the same period of time with a close today of $494.30 versus a close on Monday, November 21^st of 489.50, for a net gain of $4.80 or .9%. Importantly, even before today’s decline in the XAU, the most recent string of higher highs in bullion elicited very little upside response for the Gold Stocks with a number of leaders struggling to make higher highs.”

At the time, and to an even greater degree heading into the weekend 12/2, we saw not only a fade taking place in Relative Strength, but also bearish cross-overs unfolding on the leading momentum gauges for Relative Strength.

HUI/XAU Composite Relative Strength vs. MACD Momentum
In the chart below, I show the HUI/XAU Composite Relative Strength Ratio on the top chart and the MACD Momentum gauge for the Ratio on the bottom clip. Note the bearish downside cross-over, which took on November 30^th and was crystallizing my Friday the 2^nd, and Monday the 5^th. This was not a pretty picture and in both prior instances when MACD crossed-over to the downside for the second time within about a two month period, the XAU and HUI promptly rolled-over as did physical gold.

Below: In the prior two instances, the R/S Ratio made two distinct peaks about two months apart. MACD peaked at high levels on the left side peak, and the failed either just above, or just below zero on the right side peak. The second down cross-over on MACD on the right side peak was deadly for the Gold Stocks -- and for Gold, as significant price declines began almost immediately.

Gold Stock to Gold R/S Ratio

Above: The Chart on the bottom clip shows the Gold Stock to Gold R/S Ratio with the “right side” MACD sell signal points highlighted in the arrow. Note that at that point in time, as the momentum was fading behind positive relative strength and tilting toward negative relative strength, we saw the price of Gold itself (top clip) very near a serious top.

Gold Price Near Best Case
In addition to the bearish picture on Relative Strength, I have also been noting a gold price that appeared to be nearing my “best case” outcome for the medium term. I noted the chart below on November 30^th with a price target for Wave 3 of $515 and an ideal price target for Wave 5 of $525.00-$528. Instead of stopping just over $510, what would have been Wave 3, the price extended to above $520 and as a result became hideously over-extended. In my view, this extension to the upside argues for a different count as commodity advances often end with an extended fifth wave. In the case of Extended Fifth Waves, as I have noted time and again, the Distance of Wave 5 is often equal to the NET Gain of Waves One thru Three.

In the case of the Gold rally of the last few months, Wave 1 began off the July 15^th low at $418.20 and Wave 3 peaked at the October 11^th high of $481.50. That’s a NET Gain for Wave 1 thru 3 of $63.60. If we then go to the low of Wave 4 at $456.10 on November 4^th and add $63.60 to that value of $456.10, we come up with a 5^th wave target of $519.40. Gold closed today, Wednesday, December 7^th at $519 in the after market and was fast approaching this target level on Monday and Tuesday of this week.

Short & Medium-Term RSI Readings
Another element of the Gold market, which has been bothering me no end over the last few days, has been both the short-term and medium-term RSI readings. On the 9-day RSI, Gold has been above +80 for a nearly unprecedented three days in a row. Looking back over the last two years, readings above +80 for physical Gold have been BIG DANGER SIGNALS with the price of Gold reacting sharply to the downside EVERY SINGLE TIME. Prior to this week, it had happened six times in the last 18 months and SIX TIMES OUT OF SIX, we saw Gold prices plunge? Anybody feeling especially lucky right now? For my taste, seeing a reading of +81.19 on Monday, a reading of +81.85 on Tuesday and now a reading of +84.51 on Wednesday has me looking for the escape hatch.

The 80/40 Rule
Remember, in Bull Markets, the RSI tends to shift to the upside out of its normal range of +70 overbought and +30 oversold, to readings of +80 overbought and +40 oversold. That’s the 80/40 Rule for bull markets. What has been moving me out the door on Gold Stocks over the last few days have been these very high readings above 80. More often than not, “80” is about as high as things get.

Compressed Scale RSIs: SUPER HOURLY RSI
In addition to the Daily RSI, I also look at what I call Compressed Scale RSIs, which are very hard to move around. In order to get overbought on one of these gauges, a market really has to be pressing steadily in one direction, --- I mean relentlessly in one direction. The circled area above shows you the readings I have been staring at (until I am blue in the face) all week long on what I call my SUPER HOURLY RSI. Simply put, it has not only been above its traditional high water mark of +60 for the last few days, but has actually been above 65. In all the time I have been watching the Gold market (some 19 years), until this week, I have never seen a Super Hourly RSI reading above +65.00. Never in 19 years! Now, granted this is a bull market and we have not seen a bull market in 25 years, so one can argue that in the future, we will see more of this type of reading. However, that does not mitigate the magnitude of the reading, which is still extremely extended and overbought even for a mega-bull market.

Back in very late November of 2004 --- right at the top, we saw a cluster of seven hours worth of readings above +60 with the highest reading, a value of +61.63. Within a few days of that reading, the price of Gold tumbled nearly $18 in one day on December 8^th.

Prior to November 2004, you have to go back to April 1, 2004 to find a Super Hourly RSI reading near +60 with a reading of +58.61 on April 1^st and prior to that a reading of +60.12 on January 6, 2004. As you can see in the chart above, the Gold action following both of those readings was not pretty and as Gold went, so did the Gold stocks.

GOLD IS CLOSE TO A MEDIUM-TERM TOP... AND CORRECTION

In my view there is a very strong possibility that Gold is dangerously close to, if not right at, an important medium-term top that will yield to a sharp correction in coming weeks. While there is a lot of guess-work involved, I would not be the least bit surprised to see Gold pull back to initially below $500 and then down to the $472 to $480 zone. Such a correction could easily last into early February 2006 and could easily retrace 50% of the recent four-month advance.

In addition to the very extended set of overbought readings on Gold, I have also noticed the rather extreme options readings, which I initially discounted somewhat due to the arbitrage play surrounding ABX, NEM and PDG. That said, in addition to my short-term Options gauges reaching medium term extremes, I noted earlier in the week, that even the Medium-Term Gauges were hitting over-extended sentiment readings. I went back and re-checked the raw data as carefully as possible and could not find any trades that appeared unduly large in the data. That tells me, at the very least, the lion's share of these figures is likely spot on and that sentiment in the Gold Stocks is running at a fevered bullish pitch. At today’s close (December 7), the Medium-Term Dollar Weighted Put/Call Premium Oscillator moved back up over +200. This is not a good sign for the Gold Stocks as we have now been at or near +200 for the balance of the last 6 days.

Medium-Term Dollar Weighted Put/Call Premium Oscillator
If I had any doubt about where sentiment stood two days ago, any of that doubt was definitely removed today wherein we saw the biggest Option day for CALL options ever seen.

Optionable Gold Stocks
In the chart below, I show the daily volume for Call Options for my universe of Optionable Gold Stocks, which includes big names like NEM, ABX, PDG, GG, GLG, AU and others. When the Placer take-over was announced, I deleted PDG and substituted GLG into the indicator. Nevertheless, we are seeing quite a spike in bullish enthusiasm as virtually everyone is now a “believer” in the Gold story.

Will the market really reward all of the Johnny-Come-Latelys who Bought NEM and ABX Call Options today? My Hunch, -- I think anyone who “bought the breakout” will be sorry they did sooner rather than later.

Medium-Term Options on Majors
In addition to the XAU Options Gauges, the Medium-Term Options gauges, based on the major Gold Stocks, are also now dangerously high. Does this mean we need to see an immediate downside reversal? Answer: No, these gauges tend to lead tops by some margin. Nevertheless, these levels represent the kind of readings, which go hat-in- hand with a serious market peak and are the kind of thing we don’t like to see in our Gold work when we are positive on the market.

In addition to the excessive bullishness seen in sentiment readings, we have been noting that breadth for the gold stocks has become more selective in recent days. Earlier this week, we saw Gold making new highs and very few Gold Stocks confirming that advance. While it is true that a number of other issues including AU, GFI, GLG, NEM, AUY and EGO have all moved to higher highs over the last few days, there are still a number of names that are lagging behind including MDG, SSRI, SIL, IAG, HMY, GG, ASA, and ABX.

As a result, the Daily A/D Line has been making a partial rally, and is actually still well below the high seen in late September. This type of bearish divergence also argues that the sector may be near or at an important peak.

Finally, with today’s advance we saw both the McClellan Oscillator and the Short Term Ratio of Up-to-Down Volume approaching fully overbought territory. While there are never any guarantees, I nevertheless continue to believe that a downside reversal in these stocks is nearby. On many leading names, including NEM, I would also note that today’s action left a ‘below mid-range close’ wherein the stocks were unable to close in the high end of the daily range. In my view, whether it was arbitrage related or not, (and this rally may well have had a great deal to do with arbitrage activity surrounding the ABX and PDG situation), the technical underpinnings of this most recent rally in both Gold and Gold Stocks appear to be on very thin ice and any small downside reversal could snowball rapidly creating a serious sell off in no time. For my part, I am more than content to stand aside for the next few days and observe the market action.

Frank

ADDENDUM to Wednesday Report written Friday – December 9th at the Close:

Since Wednesday’s update, nothing has changed in our generally bearish view. In fact, Friday’s action went along to validating our working theory that the Gold and Precious Metals Complex is about to correct and potentially correct very sharply.

With Gold opening sharply higher, up at one point nearly $11.00, prices slipped back off their highs. The 9-Day RSI for Gold Bullion is now over +80 for five consecutive days Friday at a historically overbought reading of +88.42. At the same time, with Gold settling up nearly $7.00 at the close, the leading gold stocks closed lower with the XAU falling 1.26 to end the week at 122.92. This is a recipe for a sharp break in the Gold market if ever I have seen one as Friday’s action in the Gold Stocks produced a bearish downside reversal day.

At week’s end, a number of technical gauges remain seriously overbought including my Ratio of Short-Term Up-to-Down Volume, which finished at 2.346 for the Gold Stocks. Looking ahead, I believe there is an excellent chance that Gold prices will correct very sharply, possibly dropping $25 to $30 in one day next week, with the XAU potentially wiping out all of the gains accrued during the last five to six weeks very quickly over the next few trading days. For its account, I would not be surprised to see an 8 to 10 point single day decline in the XAU in the near future. The current combination of extreme overbought technical readings and very excessive bullish sentiment is normally a strong recipe for a massive correction, and through the end of the week we still saw very heavy Call Volumes crossing the tape on leading Gold Stocks.

IT COULD TURN UGLY

As a result, my Medium-Term Dollar Weighted Ratio of Puts to Calls ended the week near its lower 100-day trading band with ultra low readings near .60. This is a outlier event and it strongly suggests that any decline in Gold and Gold Stocks could turn ugly in a hurry.

Above: My Short-Term Ratio of Up to Down Volume for Gold Stocks, which is now fully overbought above 2.00 and Below: the Medium-Term Dollar Weighted Put-Call Premium Ratio for Gold Stocks, which below .70 reflects massive optimism and heavy call volumes over the last few days, in particular.

In summary, I expect a medium-term correction to begin at once in Gold with a corrective target most likely in the $470 area over the next two to three months. Under that outcome, if Gold can hold $470 support, then the argument will remain for a very strong year to the upside in 2006. However, there is some risk that the current peak could be more substantial than we currently believe and any move below $470 in coming weeks would argue for a more extended correction. Under this outcome, the downside action in Gold could persist into late 2006 and see Gold prices decline as far down as $410 to $420. While I believe this is the less likely outcome, an alternate count if you will, it is worth mentioning because some of the technical extremes, which we are seeing in this market right now are so off-the-scale that that the top in Gold could turn out to be more important than I would have imagined. This worst case scenario is outlined in the Elliott Wave Count below and is another reason to be extra careful going forward.

Frank

All Rights Reserved. Frank Barbera Copyright 2005. All information is believed to be accurate, but no guarantee can be made that future results will match past performance. Frank Barbera receives no compensation of any kind for his opinions or views on individual stocks.

© 2005 Frank Barbera
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