We're very close to a great buying opportunity in gold

published 26 January 2011

The eyes of precious metals' investors are watering.

2011 has not been a good year so far.

We are not even through the first month and the price of gold is down $100 an ounce, or 7%. Its volatile sister silver is down almost 15%, as are the large cap gold stocks. The junior producers, meanwhile, have fallen some 20%.

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Ouch...

Market corrections are normal - and welcome

The first thing I would say is that these corrections happen. This is nothing new. There's nothing abnormal here. Since 2001, when this bull market began, we have had at least one such correction, usually two, every year, as sure as eggs are eggs.

I illustrate this with a chart of silver since 2004 - see below. (Gold and gold stocks are the same, but the corrections are more apparent in the silver chart, because of its volatility). Except for the comparatively flat year that was 2005, these corrections have been at least a twice-yearly occurrence.

I welcome the corrections as they restore some sanity to an overheating market. And let's face it, this autumn gold and silver got overheated.

They also present opportunities to re-invest. The long-term picture for gold and gold stocks remains positive. The rationale for buying hasn't changed. We're still facing a decline in the purchasing power of money against a backdrop of excessive debt and institutionalised monetary irresponsibility.

As for junior gold stocks, you need only consider the longer-term objectives of the company and the potential for growth and development, once properties are fully explored and production is at full tilt.

If you were to liken a gold company to a man's life cycle, then a senior gold stock might be your gent in his 50s or 60s, who has already - career-wise (with some notable exceptions) - done much of what he is going to do. Your junior producer is your younger man who still has much of his high-achieving 30s and 40s ahead of him. While your explorer is your student or graduate in his early 20s, who is still figuring out exactly what it is he is going to do with his life.

Look on this correction as an inevitable transgression in his development, a temporary aberration, a jolly.

So as long as you're not too geared or leveraged (using too much margin via a spreadbet for example), it's pretty easy to stay focused on the longer-term picture. And I don't see much need to use leverage when playing gold. Junior mining companies are so volatile they can be your gearing. Others do use leverage - some successfully - but the problem I have is that it is too easy to get shaken out.

So how long will this correction last?

Since the beginning of this bull market, in seven of the last ten years, the low for the year in gold has come in either January or February. The exceptions to this were 2003, when the low came around late March/early April; 2004, when it came in May and 2008 - the outlier year - when it came in October. Based on this, there is a good chance that we are close to lows for the year.

Second, we are nearing my target stated a few weeks back of gold's 144-day moving average - the average price of gold over the last 144 trading days. That average now sits at $1,305, and rising. Since the crash of 2008, gold has consistently found support there.

For sterling buyers of gold, the 200- and 252-day moving averages (blue and red lines) have both been pretty reliable indicators. They currently sit above the £800 per ounce mark.

The same goes for gold stocks. The 252-day moving average often marks a good entry point. Here we see the HUI, the index of unhedged gold stocks, with the moving average underneath in blue.

(If you want to buy a basket of gold stocks, US:GDX is the ticker for the exchange-traded fund (ETF) that tracks them, and US:GDXJ for the juniors).

In short, we are not far off the zone where - by my reckoning - some 'dipping back in' makes sense.

However, this does seem to be unravelling very fast. Perhaps I am being complacent here. We shall soon find out.

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