Dear Reader,

All day long I have analysts screaming about shorting this market. Everyone is calling for a market correction.

And yet it moves ever upwards!

But eventually a correction will come, and when it does, gold will be the place to protect your money.

Last week, we saw the gold price come back and bottom at $1,370.80, then turn and begin to rise on the back of a stronger dollar. Of course, a stronger dollar means a weaker rand (all things being equal) and we’ve seen our local currency weaken this year all the way from 6.5797 to 6.8755 in dollar terms this year. The weaker currency has allowed most of the South African gold stocks to weather the latest meltdown in the gold price fairly well.

If you strip out the dollar component of the gold price you’ll see the “real” value of gold isn’t showing the volatility you’d expect. Most of the dramatic movements are coming from the buffeting it’s getting from the re-rating storms blown up by the world’s fiat currencies. 

With the secular gold bull trend still in place this recent pullback could be a great buying opportunity. But the question is: How long should you wait before you start buying up the yellow metal?

Today, renowned technical analyst Dominic Frisby reveals how to work out the exact levels at which to buy gold…

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From Dominic Frisby, in London

Dear Reader,

Gold and silver have both entered a correction phase.

Gold began 2011 at around $1,420 an ounce. The week before last it was more than 3% lower at $1,370. Silver, meanwhile, toasted the New Year at around $31 an ounce. Celebrations were due - it had risen some 80% in 2010 - but the hangover quickly set in. A week later it was down more than 5% at around $28.60.

But gold and silver have had a stellar 12 months. This correction is overdue. And it's one that I welcome. Nothing goes up in a straight line and all that. Ultimately, it will add to the longevity of this bull market.

How low will gold go?

The fundamental argument for gold has not changed. The world over, we still have inflation, deflation, negative real rates of interest, unpayable debts at most levels of society, unsustainable deficits, out-of-control government spending, misguided monetary policy leading to mal-investment, excessive speculation and bubbles - I could go on.

There are many drivers to this bull market in gold, and none have gone away. Nevertheless, corrections are inevitable. We have one now. The question is: 'How low will it go?'

I'd like to try and answer that, as I feel I've made a bit of a discovery: the 144-day moving average. It doesn't sound that exciting, but it's amazing how well it has been working over the last two years.

There are 252 trading days in a year. Prior to the crash of 2008, once or twice a year, gold would return to its 252-day moving average (the average price of gold over the previous 252 days). It would flirt with it for a while, before making its next move up.

Here is a chart of gold from 2001 to 2008, which demonstrates this:

However, since rebounding off the crash of 2008, it has not gone back to this line once. Rather, the 144-day moving average (blue line on the chart below) has been the line to which gold has returned. It seems to go there two or three times a year.

That 144-day moving average currently lies at around $1,300 an ounce and rising. I suspect we will get to it on this correction. If we follow the time scale of previous corrections, then we should reach the low towards the end of January.

If gold bursts down through that line with volume, then we are in for something a bit more serious than a normal, ongoing bull-market correction. But I am fairly confident it will hold, barring some sort of global liquidity panic.

If gold does get to this line, one low-risk trade might be to buy gold at the moving average with a stop just below.

I should say that when gold corrects, you usually see one wave of selling. This is followed by a bounce, which is then followed by a second wave of selling, at the bottom of which you see the low.

We have had the first wave of selling and, as I write this, we now seem to be enjoying the bounce. So it's likely that that second wave of selling is just around the corner.

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The three phases of bull markets

It is said that a major bull market has three phases. The first phase is the stealth phase, where only the 'smart money' gets onboard. This is followed by a correction. The second phase, typically the longest, is known as the 'wall of worry' phase. This is when more and more institutions start to come onboard, the sector receives more and more media coverage, but there is still a great deal of incredulity and denial. People think they are too late to invest.

Finally, we have the euphoria - the mania phase - where the proverbial shoe shine boy starts giving you advice.

If you look at stock markets, you saw this stealth phase between 1980 and 1987, before we got the crash. From 1987 to the Asian crisis of 1998 we enjoyed phase 2, the 'wall of worry' phase. Then from 1999 to 2000 came the insanity.

This is a fairly arbitrary cycle of course. But I would argue that we are somewhere in phase 2 in this gold bull market. I am still amazed at how few people actually own gold. Phase 1, the stealth phase, was between 2001 and 2008 and ended with that bone-shaking meltdown.

Gold consistently found support during phase 1 pullbacks at its one-year or 252-day moving average. With the acceleration that you often see in part 2, perhaps the 144-day moving average will define this second 'wall of worry' phase, consistently marking support. We shall see.

It's worth noting that since its first November high, gold has lagged the broader US indices, which have gone on to post higher highs. Like gold, however, emerging market indices also lagged.

As I have noted before, we have been in an 'all-one-market' environment, where all asset classes rise as the US dollar falls and vice versa. But if, as we're seeing now, not all markets are rising together anymore, then we have something to think about. Just as gold's high was unconfirmed by the gold stocks, the S&P 500's recent high has been unconfirmed by other global indices. That could portend trouble ahead for the US market.

Nevertheless, I am looking for a turbulent month which should see a move for gold back to its 144-day moving average, where I am guessing it might find support. That - hopefully - will mark yet another entry-point into this wonderful bull market.

Until next time,

Dominic Frisby

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