Wave Analysis of the Gold Bugs Index
 
The bull market in gold stocks which began in late 2000 is still in progress. There is no reason to believe that it will not continue its long term bull trend. While this analyst doesn’t “own� Elliott Wave (EW) theory, an interpretation of the theory leads to strong technical evidence to suggest that the HUI is nearing the completion of a correction against the secular bull trend that will resume in a relatively short amount of time, probably measured in weeks. I’ll make my case in tonight’s article.

First, a disclaimer. Kindly disregard this analysis if the HUI swoons to where it closes a week below 250. Given that the HUI closed Wednesday at about 346, this analysis presents too much risk to utilize as a short term trading tool. Those wishing to trade would need to focus their attention on the shorter term.

The chart above illustrates the weekly chart of the HUI including the final throws of the bear market and the formation of the new bull market which was confirmed when the black downward sloping trendline was broken decisively. In this wave interpretation, the HUI has completed Wave I of a 5-wave bull market. As is the case in Elliott Wave, Wave I breaks down into 5 waves, 3 up and 2 down, indicated in blue. Within the 5 blue waves indicated in the chart it is important to note the characteristics of the up waves (waves 1, 3 and 5) versus the down waves (waves 2 and 4). The up waves are relatively straight and decisive, whereas the down waves are indecisive and wiggly. This is because the secular trend is up and the corrective waves are opposing the long term secular trend. This would be similar in principle to peddling a bicycle downhill versus uphill. Following the path of least resistance (downhill, or the secular trend), it is easy to peddle the bike in a straight line; whereas peddling uphill or against the trend would result in an irregular path and it would be difficult to steer the bike in a straight line. The wiggly patterns of Waves 2 and 4 suggest that the HUI is moving against the secular (up) trend, whereas the straight lines in Waves 1, 3 and 5 suggest that UP is the path of least resistance, or secular trend.
 
Notice that Wave 2 differs from Wave 4 in terms of duration and shape following the principle of alternation in EW theory.

Following the completion of Wave I, the HUI entered into a longer term a,b,c correction against the upward secular trend. This longer term correction began in the late fall of 2003 and lasted until mid year 2004. It is logical and well within Elliott Wave theory that an uptrend lasting about 3 years would take about 1-1/2 years to correct. Beginning mid year 2005, the HUI again entered into the previous pattern of straight and decisive upward action. Notice how the move from II the second blue Wave 1 follows a straight path similar to a bike coasting down a hill or a boat going downstream.
 
Shortly after the New Year (2006) the action of the HUI tried to buck the secular uptrend. The action reminds me of a salmon swimming upstream. It was trying to move downward but the secular upward trend won’t let it do so easily. If the high marked by the blue 1 on the chart ended Wave 1, then in time duration, the present correction appears to be ready to run its course – its duration is already longer than the previous corrective blue Wave 2, but not quite as long as previous blue Wave 4. However, if the dark green 5-wave uptrend better defines the blue Wave 1, the present corrective wave is likely to last a few weeks longer. The duration of the blue Wave 1 and Wave 2 would tend to support the corrective Wave 2 beginning shortly after the New Year; the following two characteristics tend to favor the alternate dark green wave count:

Irregular corrective patterns that make a higher high are relatively rare. (Although a case could be made for the strength of the secular up trend to make for irregular corrective patterns against the main trend.)

3rd waves tend to end with higher momentum than 5th waves. Note the momentum divergence that appears between dark green wave 3 and wave 5 supports the dark green 5-wave leg. This wave count suggests that more squiggly action is due for the HUI in the coming weeks.

A closer look at the daily action (below) tends to favor the latter dark green interpretation whereby the uptrend in the gold bugs index didn’t end until May of 2006. The HUI has corrected by about 50%, an acceptable amount; however the duration of the correction (3 month correction of a 1 year uptrend) probably suggests more “upstream� squiggly action for gold stock bulls in the next few weeks.

However, for the long term, it is important for investors to not lose site of the big picture which is a long term and relatively straight decisive uptrend. This is a “trend� that has not shown any signs of abating and should serve as a reminder that as long as position sizes are appropriate, the most important yet difficult thing to do in a bull market is to hold your position.