By Mary Anne & Pamela Aden, Posted Thursday, February 25, 2010

Gold, silver and the metals group are coming down from their January highs, on the eve of gold's nine year bull market run. Considering the gold price has had nine consistent yearly gains, and it's still above $1000 is a feat in itself. Gold's bull market is solid, a new phase has begun and it's currently declining in a sharp, yet normal downward correction.

Corrections tend to cause fear. And considering the volatility we've seen in recent years, the fear level rises fast. The word bubble is the buzz word, and it's understandable since we've had so many over the last decade. The tech bubble was followed by the housing bubble, the credit bubble, and the debt bubble that continues to grow.

The debt bubble is an ongoing reality; it's international in scope and it's the biggest ever. This is hanging over our heads and over the markets, and it isn't going away, it's just getting bigger.

GOLD RISES WITH UNCERTAINTY

Debt monsters of the past have tended to end in deflationary depressions, but it's important to understand that gold can rise in this kind of environment. Remember, gold rises during economic uncertainty. In the early 1930s, for example, during the Great Depression, President Roosevelt raised the price of gold almost 70% from $20.65 to $35 an ounce in a struggle to bring back inflation.

Gold is money. It's the currency of last resort when monetary times are difficult. So when gold rises in all currencies, as it's been doing for several years, you know the rise is enduring and superior (see Chart 1). So even though gold has no yield or earnings to measure like the other markets do, it has true value.

The central banks are flooding the markets with their own currencies, and competitive devaluations will continue to grow. Many countries depend on exports for economic survival. This means the best price in the current deflationary environment wins, which is what a cheaper currency does.

This situation originally started with globalization and it's bullish for gold. The U.S. is still in a delicate situation. It needs a weaker dollar to compete and stimulus measures must continue, which are both ultimately bullish for gold.

This is one important reason why we do not think gold or commodities are in a bubble. We believe they are rising within a mega trend that could last several more years, perhaps a decade. Some say that China is in a bubble and if they are, the demand for commodities will fall. China may be overheated but we don't think it's in a bubble. Their growth, even if it's only a part of what they claim, is solid.

DEMAND IS GOOD

Commodities are in demand and this continues growing with each passing month. China is the engine for demand. It's the biggest consumer of many raw materials, like aluminum, copper and iron ore. In fact, just last month the number of iron ore and coal ships hired to carry cargo to China jumped 38%.

Rio Tinto, the second largest resource company in the world, forecasts that China's consumption will be more than double by 2020. That's only 10 years away.

China and other countries are also buying gold. It currently only makes up about 2% of the reserves in emerging markets. With the average being 10%, there is interest and a need to continue adding gold to their reserves.

Aside from central banks, mutual funds are adding gold to their portfolios as well. This month, the second biggest U.S. public pension, the California State Teachers retirement system, is considering investments in commodities in order to boost returns and provide a hedge against inflation.

Yes, gold is slowly making its way into mainstream investing, in large part thanks to the Exchange Traded Funds, ETFs. They have made it easy to invest in gold and commodities.

BAD NEWS COINCIDES WITH DECLINING MARKET

Debt and how it's handled will be the driving force in the markets looking out to the years ahead. And interest on the debt, compounded, will be the biggest problem.

This is why there are so many doubts that the economic recovery will be sustained. The commodities, metals and energy fell sharply in recent weeks on concern that rising job losses in the U.S., and mounting debt in Europe, will slow economic growth and, therefore, curb demand.

Interestingly, this type of news becomes more common when the markets are due for a downward correction anyway. The great rises in the metals and crude oil were overextended and they've been poised for a downward correction.

With copper being the global economic barometer, the fact that it fell sharply for the first time since the rise began a year ago, provided a good example of bad news hitting an overextended market. A bull market decline is now underway.

Gold is a good example too. Its seven month rise that peaked in November, which we call the C rise, was a bullish one that had reached maturity. By gaining 40% and meeting our original target level, we knew the bulk of the rise was over, for the time being.

GOLD: “D” decline underway

A D decline is now underway. These declines tend to be the sharpest intermediate declines in a bull market, and so far this one is following the pattern. Chart 2 shows that gold's leading indicator (B) declined clearly below its uptrend and it could now fall to the low area while the gold price itself stays under downward pressure.

The $1000 level is a key support area, which is near the prior C peak in 2008. The 65 week moving average, now at $975 is rising and it's set to reach the $1000 level in a few months, which will further reinforce the support at $1000. For now, $975 to $1000 is the strong support level for gold.

Interestingly, gold at $975 would be a 20% decline from the November $1218 peak. The worst D decline so far in the current bull market was in 2008 during the financial meltdown. Gold fell almost 30% from March to November. This was an extreme case in an extreme situation. A decline to the $950 level would be similar to the 2006 D decline, which was the second worst decline since 2001.

In other words, the extent of the decline is about half over. As for timing… since 2004, the D declines have been lasting about twice as long compared to the first years of the bull. This means we could see the decline end any time from here on out, if it's on the shorter end, but more likely it could last until April.

Pressure is likely to stay on gold and the metals in the weeks ahead, which means it's time to take advantage of weakness by adding or buying new positions. Gold's major trend remains up, indicating it's headed higher. But for now, it will temporarily remain under downward pressure by staying below $1110.

by Mary Anne & Pamela Aden,