Gold: is this drop a normal seasonal correction? Or something worse?

Last month, I gave three reasons why I thought we could expect to see a pullback in precious metals prices in the near future.

One, because there was a lot of resistance at the $1,800 an ounce mark for gold (and around $35 an ounce for silver).

Two, because there was too much bullish sentiment, particularly for silver.

And three, simply because in early October for some reason you almost always see some kind of shake-out in the precious metals.

“It will be like some short, sharp punch in the ribs,” I said. “Enough to rattle everybody’s nerves and cause a bit of pain”.

Well, I don’t know about you, but my nerves were rattled on Monday. Silver was pole-axed. The mining stocks looked little better.

So is this just the shake-out I expected? Or is it the start of something worse?

Gold could drop through $1,700 in the short term

Looking first at gold, what we’re seeing now reminds me of 2006-2007. Take a look at the chart below.

Gold price 2006-2007

(Click on the chart for  a larger version)

In the spring of 2006, gold stormed to $730 an ounce – doesn’t that seem cheap now? It then had a horrible correction all the way back to $560.

It spent the next year or so, after re-testing that $560 level, unable to get through $680-$700 (where I have drawn the pink band on the chart). It eventually made it through after several tries, then went on to storm to new highs.

But I remember there being much frustration and doubt as gold meandered between $640 and $700 in the first half of 2007.

We’re in just such a sideways period now.

The September 2011 high of $1,920 is like the old $730 number. The area between $1,780 and $1,800 is like that seemingly insuperable $680-$700 area. And $1,520 is like $560, the area of ultimate support.

Looking at the chart immediately below, which shows gold over the last 20 months, you can see how similar the pattern is. I’ve reprinted the earlier chart below it, so you can compare them. 

Gold price over the last 20 months

(Click on the chart for  a larger version)

Gold price 2006-2007

(Click on the chart for  a larger version)

I’m going to stock my neck out and say that the $1,700 mark (we are currently at $1,740) isn’t going to hold.

But I see a lot of support in the mid- to high-$1,600s. Both the 252-day moving average (green line) and 144-day moving average (red line) – which have good track records as indicators – as well as the rising blue trend line I have drawn, should all convene at around those levels and provide decent support.

If that thesis plays out, then silver should find support around $30. But silver being silver, anything is possible, and it really wouldn’t surprise me if it paid $26 yet another visit.

If so, I would expect $26 to hold – unless the world is gripped by yet another panic, of which there are many potential causes lurking.

But – who knows? – the correction may have ended on Monday

The long run is looking good for precious metals

In any case, looking further forward I am feeling rather positive. Talking gold at the weekend with some buddies, the subject of how gold and gold shares perform during post-US-election years came up.

Given that our friends across the pond are deep into their electoral process – or silly season as perhaps it should be called – I had a look some charts and did some back-testing.

The good news is that gold has a habit of doing rather well following US election years.

Below, we see gold since 1970 with red arrows marking each of the 10 post-election years during that period – 1973, 1977, 1981, 1985, 1989, 1993, 1997, 2001, 2005 and 2009.

Gold price since 1970 US elections marked

(Click on the chart for  a larger version)

Gold rose in all but three of them – 1981, 1989 and 1997. Given that those 40 years include 20 years of bear market, that’s a pretty impressive statistic.

I only have charts for the XAU (gold stocks index) going back to 1984. But the gold stocks in this period did even better than gold in post-election years, as you can see below. Gold stocks fell in just one (1997) of the past seven post-election years.

In 1989 when gold was pretty much flat on the year – though with hefty declines in the middle – the XAU ended the year over 50% higher.

XAU (gold stocks index) going back to 1984

(Click on the chart for  a larger version)

So, while the period between now and the election might be decidedly rocky, it all looks very good for 2013. I’m confident both gold and gold shares will have long since broken out to new highs 15 months from now.

For more on which gold mining shares you should consider adding to your portfolio, check out my colleague Simon Popple’s newsletter, Metals and Miners.

Finally, a heads up on African Queen Mines (TSX-V:AQ), which I mentioned in a Money Morning a few weeks back. African Barrick has just announced that it is buying the ground next to African Queen’s Ugunja project in Kenya, via its purchase of Aviva Mining Kenya. That could mean absolutely nothing, but it could also mean it thinks there’s something there, which would be a promising development (full disclosure: I hold shares in African Queen).

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