Jan 15, 2011

Gold Price Correction: Odds Are this Correction is a Real Opportunity

By Andrew Mickey, Q1 Publishing

It seems like the proverbial canary in the coal mine.

Stocks posted their seventh straight week of gains.

The VIX (a.k.a. the “Fear Index”) has fallen to levels last seen when the Dow was above 14,000 in 2007.

Even 50 Cent made the headlines as a newly-minted stock guru. The rapper/mogul exposed his large twitter following to shares in an OTC Bulletin Board-listed penny stock that was marketing his new line of headphones. The tweet sent shares of the company from 10 cents to a high of 39 cents.

The bullish fervor and brazen disregard for risk is almost too much at this point. But despite it all, the top-performing asset of the past decade has fallen into a correction.

That’s right, gold has bucked the everything-goes-up trend and has fallen 5% over the past month. Some of the most ardent gold bulls have started to accept it can’t go straight up forever.

Even long-time gold and commodities bull Jim Rogers sees a pause in gold’s run. He warned last week gold is “overdue for a rest” and “may go down for a while.” He added that he still expects gold to hit $2,000 this decade despite the current correction.

So what’s a gold investor do now. Sell now, buy later? Wait it out? Or simply just continue to buy.

As usual, history provides an excellent precedent for how long the current gold correction will be, how long it will take to recover, and when to make your move back into gold stocks.

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Gold’s Correction Limbo: How Low Can it Gold

Gold has historically been one of the most volatile asset classes.

At the height of the bull market in the late-19709s, gold prices would swing 5% to 10% in a single day.

Gold hasn’t been quite as volatile in the current bull market though.

The chart below shows the five largest corrections in gold prices over the last five years:

The data reveals a lot about what to expect during this correction.

Gold prices fell an average of 16% during each of the corrections. If this is an average correction, gold would fall below $1250 before resuming its uptrend.

The average correction lasted four months. That would put gold’s next temporary bottom in May. That’s a long time to wait out a correction in real time. But for investors focused on the medium-term, four months isn’t that long at all.

The old adage, prices take the stairs up and elevator down, has been true for gold prices too. After the average four month correction, it took an average of seven and a half months to fully recover to the price at which the decline started.

The averages, however, are hardly a predictor of future results. For example, if we treat the data from credit crunch as an anomaly and remove it, the average price decline is only 12.5%.

They are, however, a reasonable guide of what to expect from the current correction.

Patience and Profits

All the data points to one most probable outcome: the correction will be relatively brief, relatively small, and, looking back at the end of this year, the entire period will be viewed as another opportunity to add a bit more positions in gold stocks to ride out the rally.

Think about it like the average investor right now.

How much are you willing to stash into some mutual fund that’s most likely going to track the overall market?

Probably not much with the Dow at nearly 12,000, stocks as a whole fundamentally overvalued by 20% to 30% by most reasonable estimates, and bonds have virtually no upside potential.

Gold, however, still looks very strong. Even the most hopeful fiscal conservative expects the U.S. government to trim $100 billion in spending this year. A miniscule amount compared to the expected $1.4 trillion deficit. The Fed has started laying the groundwork to extend its quantitative easing efforts. Stagflation has already set in. And the majority of investors still haven’t considered gold.

Over time, more and more investors are starting to view it the same way. Once they get burned chasing a 5% gain in stocks while a 10% to 15% correction looms and piling into “no-upside” bonds, they’re turn to gold. And as the bull market continues and gold prices set new highs, more investors are going to start buying gold and gold stocks.

Whether this correction turns out to be a strong 19% drop in gold prices or a relatively benign 8% drop, odds are it will not last too long and will eventually be used as another opportunity to buy into one of the strongest bull markets of the next decade at a good price.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

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