Good-sized rebound in gold mining stocks in order

by John Lee

06/05/2006

Dollar and Bonds:

From the May 16th Update

“The dollar index has lost more than 6% in the last 6 weeks. The euro is now approaching the 1.3 level. Given how fast the euro's rise and dollar's decline have been, a breather is due. The Euro could retest support of 1.25 before breaking out of 1.3. Any short term rally for the dollar will be of dead-cat bounce variety, which will not last past this summer. We don't envision the dollar index breaking below 80, which means the downside is fairly limited at this point.”

We were ambivalent towards the short-term rebound in the dollar in the last update. The failure of the dollar to stage any meaningful recovery in May after the 6% fall in April shows that the dollar is in terrible shape. At the same time we were surprised by how well the Euro has held up in May given its big run up in April. The Euro might hang around upper the 1.20's for the next few weeks but a firm breakout above 1.3 is in the cards by this Fall. This is our conservative view.

Like the dollar index, US long bonds failed to stage any meaningful rebound in May. The long term trend stays bearish.

Gold and Silver:

From the May 16th Update

“Since the update gold blasted past our $650 target and went as high as $720/oz. The ferocity of the rise caught us by surprise and indicated a short term peak might be in place for the next 2-3 months. Summer is traditionally slow for gold, which allows it to gather steam for a final assault this fall. Silver has been very volatile but we expect it remain above its 50 day-moving-average (currently at $12).”

Since hitting a 26 year high of $730/oz in mid-May, gold has fallen about $100 to $630. We were surprised by the scale of gold's fall in the face of a steady Euro. We think gold's downside from here is very limited (10% at the most). A firm breakout by the Euro above 1.3 will mean gold is ready to retest this year's high of $730. We expect gold to return to rally mode in September but wouldn't be surprised if gold retest $700 in the Summer. Silver's action will continue to amplify that in gold.

XAU

From the May 16th Update

“The XAU staged a fake breakout above 160 last week. The worst scenario is for it to retest the 200DMA support of 125. We however see that the XAU will most likely stay above the 140 level while bottoming between 125-145 this summer.”

The XAU did briefly dip below 140 and closed down 10% for May. The junior mining sector faired much worse, with many popular issues down as much as 50% in May. We would rate this past May as one of the top three biggest single month declines in junior/exploration stocks since the gold bull started in 2001. Consequently we expect a healthy rebound in June. Many junior stocks are trading as if gold is at $500. We believe the sector currently presents a wonderful, low-risk entry point.

The ratio of XAU over gold already shows gold stocks on the rebound. We expect gold stocks to outperform gold in the next few months.

CRB and Oil

From the May 16th Update

“The CRB remains in a nice uptrend, while oil is struggling to break out of $70 convincingly. Both the CRB and Oil are comfortably in an uptrend.”

Crude oil failed to break away from $70, while the CRB remains comfortably in an uptrend. Neither of the markets are a cause for alarm for metal bugs.

S&P500, Nikkei, Shanghai

From the May 16th Update

“The S&P500 stayed within the bearish rising wedge. Nikkei corrected with a rising yen, while Shanghai staged an emphatic breakout. The talk of a rising RMB has speculative money pouring in China.”

Both the US and Japanese equity market staged a sell off in May, with S&P500 down over 3% and Nasdaq down over 6%. The long term charts show the S&P has not yet broken down from its bearish rising wedge while the Nikkei is still above its 200 DMA uptrend.

Conclusion:

We concluded on May 16,

"We seemed to have a mini blow-off for gold and silver. The Euro is also due for a breather at the key 1.3 resistance level. This may mean we will have a slow summer before September when gold action starts to pick up again."

Both gold and gold equity staged dramatic declines in May; with each down 15% from their 2006 peaks. Speculative junior mining issues were down some 30 to 50% in May. The magnitude of the fall was somewhat unexpected given the dollar index didn't manage to stage any meaningful rebound and the Euro is readying for a breakout over 1.3.

If we single out Newmont as an example, the stock first reached $50 in Dec 2003 when gold was $425. Last Friday Newmont closed at $53.3 when gold closed above $620. In short order, either gold is to correct below $500 to reflect Nem's $50 price, or the market just shook out all of the weakhands and is ready to propel Nem to a much higher price to match the current gold price. We believe in the latter case and therefore think that this is the last chance to load up gold stocks on the cheap in view of $600 gold price that is set to go higher this year.