Sunday, January 22, 2006

A quick note on the HUI

The precious metal equities are the highest weighted sector in my overall portfolio. I didn’t chase the sector because of the blistering performance since the Q4 of last year; instead I have been investing in gold since 2002. I started with the Tocqueville gold fund (TGLDX), and gradually through studying and learning from mistakes (and there are plenty), gained enough confidence to invest and trade in individual issues.

Let’s first take a longer term view. Using the Amex gold bugs index (HUI) as a proxy, the 10 year chart below illustrates the tremendous gains in this sector since its bottom in 2001. The numbers and roman numerals label the waves according to the Elliott Wave Analysis (EWA). After an initial 3 yr wave I up and 1.5 yr wave II side ways correction, we have now firmly started wave III which should last at least 3 yrs if not more. If wave 1 of III is similar in magnitude to wave 1 of I, than a gain of 110% from the start, or 353 = 2.1 * 168 can be expected before a significant correction lasting until the end of 2006. In terms of duration, wave 1 of I lasted 6 mos which we have already surpassed since the start of this wave in May of 2005, the next target is 1.5 or 1.618 * 6 mons, placing us in March of 2006. My plan is to take profit in at least 50% of my positions at that point. This quick note is called for because the sector is now at a critical juncture as shown in the 12 mo chart below. I believe the wave (4) of 1 of III has just started and should take us to the 50 dma which is a 10 % correction from the current levels before launching upwards again. My investment style doesn’t prescribe any action other than sitting tight at this point. Of course, I could be wrong and would be giving back a large portion of my gains. Such is the risk that we take. However, I would argue that the composition of gold/silver investor has changed as wave III commenced (I won’t talk about the causal issues here.), and a parabolic rise as seen at during wave I.1 and I.3 has yet to come. I’ll be paying very close attention to the stochastics of leading gold/silver stocks as the HUI approaches 275.

I would have liked to have written some background posts on gold/silver as well as prepared some introductory reading material on EWA before this note. However, the unfolding of events required taking an unambiguous stance now. If the readers are interested in exploring more of Elliott wave analysis, some recommended readings follow.

Recommended readings

Other books on Elliott wave analysis from Amazon.com