Will there be a gold price correction?

published 22 June 2006

We have been writing in the newsletter and telling clients that our first target for gold bullion was $500/oz and for quite a long time now we have been suggesting that it might be reached before year end. It reached it before the end of November.

Our first thought was to lighten up positions. However, so far price action has been very encouraging, not just for gold bullion but for the complete precious metal family. It is our view that the gold price might move further ahead and the weight of new money will overcome any profit taking.

The unfinished bull market for gold bullion has hit our intermediate target before the year-end. So, we now raise our eyes to the next target which is the all-time high set in January 1980 of $880/oz, but what in the meantime?

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Bull market in gold: technical indicators

As we have said in previous issues of this newsletter and as is now being echoed elsewhere, $500/oz is potentially a major resistance level for gold bullion so we are watching the action. Nonetheless, the gold price might well head further north. After all, we only recently entered the second important stage of this primary bull market.

We are nowhere near the third stage one of euphoria.

The second important stage commenced earlier this year, when gold bullion shook off the shackles of being an inversion of the weak dollar. It has this year reached this important level on the back of a strong dollar, which means that it has enjoyed very significant investment growth in almost all of the world's major currencies. No wonder, it was the Japanese who piled in to cause this level to be first breached.

In an earlier note, we explained the ratio, calculated by dividing into the gold price, the price of the Philadelphia Exchange Gold & Silver Index. This ratio plots the relative strength of shares versus the metal, it moves between the extremes of 5 and 3. In June, gold mining shares were at a low relative to gold bullion, the ratio was 5. We would expect from there for the ratio to move to 3. At the time of writing, the ratio is still very high at 4.4! This suggests a prolonged period of relatively stronger gold mining share prices.

Technicals are very important because they tell you what people are doing with their money. The current level is very bullish for gold mining shares in spite of the $500/oz technical level of resistance for gold bullion. Look at the chart for the PHLX Gold & Silver Index. From 15th May 2000, you will see that prices moved in a wide trading range of between $78 and $115. Look carefully at the most recent price action since 26th September 2005, initially the price turned down. The most likely outcome of that action would have been a fall back to the low of the trading range at $78. Something else quite different happened. After a modest setback, the price then advanced and broke above the previous long-term range high and since then has gone higher very bullish. This recent break-out is indicative of significant new money piling in. Whilst the Philadelphia Gold & Silver Index remains above 100, we remain very bullish about investments in gold mining shares, such as the Merrill Lynch Gold & General fund.

Bull market in gold: predictions

We remain committed to this long-term investment. We genuinely believe the gold price will, in due course, reach at least $1000/oz and that investments in gold mining shares will prove to be amongst the best possible investments to hold. Any adjustment that we make to portfolios is a money management process not a loss of faith in this exciting investment.

We have already discussed the comparison between gold bullion and gold mining shares. The other important comparison to make is gold bullion to other precious metals. Here additional comfort is available. Platinum, silver and the laggard palladium have also moved very positively higher. We will continue to watch this situation which David Fuller, of "Fuller Money", calls commonality'. If gold remains secure at this level, then each of the other precious metals will also hold the line because a weakness in one might well be an early signal of a downside risk for all.

By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.