By Nick Jones
Editor, Real Deal

The PMs have taken the back seat in the most recent rally in commodities. While corn, soy beans, oil, and other commodities were making either fresh contract or all time highs on a daily basis, the PMs simply consolidated. This was to be expected after the fantastic rally in gold from the low $600s to above $1000 /oz. Personally, I exited the last of my PM equities positions at $975 /oz and have been on the side lines ever since (I do still own physical metals). But I believe that we are currently encroaching a good entry point in the PMs. I’m normally not a big chart guy, but I would like to throw some charts at you and explain why I will be doing some discount shopping for my favorite mining stocks in the not so distant future.

The first chart I would like to discuss is the 3 year daily chart.

Please take not of the similar chart patterns in the circled area. After spectacular rallies, following both the May 06 rally and the most recent rally at the beginning of this year, gold entered a consolidation period that took the form of a descending triangle. Gold proceeded to break out at $625 /oz and rallied, at its peak, to a 60% plus gain. The other point about this chart that I would like to point out is the extremely strong underlying support that the 200 day MA has acted as. In rare instances, such as the one immediately following the 06 peak, gold briefly broke below its 200 day MA, but it didn’t stay there for long.

The next chart I’m going to look at is the 3 year weekly chart.

I like weekly and monthly charts simply because they drown out some of the intra day noise that might show up in a daily chart. You will notice that this chart has some strong similarities to that of the daily chart. It has the same descending triangle formations following intermediate peaks. Even more so than the 200 day MA in the daily chart, the 50 week MA been pretty much unbreakable during this bull rally.

So where does that put us? Although I think we are getting close to an entry point in this market, I don’t think we are quite there yet. In the daily chart, I would like to see, and fully expect, the 50 day MA, 200 day MA, and spot price really consolidate tightly. We have entered a trading period where the spot price is trading between the 50 and 200 day MAs. They will continue to squeeze together, until something breaks. This is a signal that a strong move is near.

In the weekly chart, I would like to see the 50 week MA fully catch up to the spot price. Again, the 50 week MA has acted as unbreakable support and I would like to get my money in at or near those levels.

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I’ve made my argument for the possible beginning of a new bullish phase in PMs, so the next question to pose is the question of how high. How high will the next rally take us? This is a difficult question to answer, especially with the ever changing atmosphere in financial markets. Given that, I believe I can make a good educated conjecture as to how high the next rally will take us. I am going to borrow a chart from my co-author John, as well as use the charts from above in order to come up with some specific numbers.

John mentioned that the last time the Gold/WTIC ration dropped to current levels, it rallied sharply to 12. Let’s go ahead and assume we move back to 12 and let’s also use current oil prices of $135 /barrel. That gives us a price of gold around $1620 /oz. But we have to also remember that there is a strong correlation between the price of oil and the price of gold. Let’s say gold rallies amidst an oil rally to $150 /barrel. With the Gold/WTIC ratio of 12 and $150 oil, we get an approximate price of $1800 /oz.

Keeping that in mind, I am going to refer back to the daily chart at the beginning of this post. The percent rise in the price of gold between the 06 breakout of $625 /oz and the peak of $1025 /oz was approximately 60%. If the next rally moved another 60%, we would be looking at a price for gold around $1600 /oz. This is consistent with the figures I derived using the gold/WTIC ratio.

Using all of the above data, I believe that the next interim high will be in the neighborhood of $1700-$1900 /oz.

There are a couple of things to keep in mind going forward. In a bull market, like the one we’ve had in gold since 2000, each consecutive bullish phase tends to move by a higher percent than the prior one. For example, although the rally to $1000 gold was approximately a 60% rally from the last intermediate high, the next rally could result in a 70% move. This is a result of the Johnny Come Latelys entering the market. Each rally simply has more investors than the prior one.

There’s another item worth noting. Although the 2007/2008 gold rally was spectacular, it didn’t shoot out of the gates sprinting. You can see that at the end of 06 and the first half of 2007 gold just didn’t move much. After a brief rally, it kind of puttered around. But looking more closely you can see that the chart was actually making higher highs and higher lows while building a solid base. We may have a period like that in the following months.

All in all, I think we are close to a really great entry point in the precious metals. I would recommend following a couple of your favorite mining stocks and getting comfortable with their price action in order to determine a proper entry level. There’s no reason to hurry, so take your time and make your moves when you’re ready.

This is not a recommendation to buy or sell, please do your own due diligence.

Nick Jones
The Real Deal