Guest Commentary - Secular Bull - Focused Investments

Gold Bull Seasonals

Since its latest interim low back in early October, gold has been rallying nicely. In the six weeks since then the Ancient Metal of Kings is up 13%. This is an impressive move by any standard, and it utterly dwarfs the much-hyped Dow 30’s 2% run higher into nominal record territory over this same period of time.

While gold certainly needed to correct and consolidate a bit after its incredible greed-laden surge that climaxed in May, gold’s current strength is not just a consequence of that necessary consolidation running its course in order to bleed rampant greed out of the metal. Although the maturing of gold’s consolidation is almost certainly the primary factor behind gold’s recent interim low and subsequent strength, a fascinating secondary factor also exists.

Gold is entering its strongest time of the year seasonally. Beginning in early November and running until early February or so, the winds of probability shift to gold’s stern. This seasonal tailwind, when combined with gold moving up for its own sentiment reasons, can lead to some impressive rallies higher.

While seasonality is certainly interesting and is a useful addition to a trader’s arsenal, the biggest risk with it is giving it more credence than it deserves. Seasonality is simply the tendency for a price to be stronger or weaker at different times during a calendar year. The important thing to remember is that a tendency is far different from a certainty.

I strongly believe seasonal analysis should only be used as a secondary type of indicator, never as a primary. This is because it is not the passage of calendar months that drives prices, but the flowing and ebbing of sentiment. And the whims of sentiment scoff at scheduling. Greed or fear can well up at any time. Big news that feeds greed or fear can break at any time. And interim highs and lows can happen at any time. Sentiment, not dates, is the key to short-term price movements.

A great recent example of seasonals failing occurred in oil and oil stocks. This year we had heavy positions in oil-stock calls that had led to extremely profitable realized gains up until early August. At that time neither oil nor oil stocks were overbought relative to their bull-to-date precedents so our primary indicators weren’t signaling an imminent correction. And on top of that, both the oil and XOI seasonals looked very favorable until late September.

Despite August and September being the best time of the year seasonally for both oil and oil stocks, oil sentiment was deteriorating on the lack of a buying catalyst and it started to correct about two months early. Since oil never topped in a typical sharp exuberant manner, and since its slide was slow and controlled, it didn’t look like a full-blown correction until too late. On some of our November oil-stock calls in particular, they swung from unrealized gains of 70% to realized losses of 70%.

Such ill fortunes are no big deal and are an expected part of speculation from time to time. Including these losses our average return on Zeal Speculator options this year is still running near +100% per trade. The real moral of this story is that strong seasonals are meaningless in the face of an adverse shift in sentiment. Seasonals exert some pressure like wind, but if the sentiment engines of a ship are steaming directly into this wind the headwind is never going to be able to overcome the sentiment.

I share this hard lesson as a fellow student of the markets because it is dangerous to read too much into gold seasonals. Nevertheless, they do certainly provide an interesting secondary perspective on the probabilities governing the gold market. And when today’s strong seasonals are combined with very bullish signals in gold’s primary indicators, it sure looks like sentiment and seasonals are aligned. Such an alignment is the best of all worlds for gold investors.

You futures traders are certainly familiar with seasonal charts as they have long been popular in the futures world. Usually in futures seasonal analysis, very long time horizons are used to build the seasonal charts. It is common to see 15 to 30 years of price data crunched to arrive at one seasonal chart. The benefit of this, of feeding in raw data for bull and bear years alike, is that secular trends are largely filtered out. A long-term seasonal chart spanning both bulls and bears is much more likely to yield pure distilled seasonality.

While I respect this classical approach, my own studies of the markets over the years inevitably show that prices behave very differently in bulls and bears on a short-term tactical basis. So as a gold and gold-stock investor and speculator today, I am most interested in how gold behaves in a bull market since it is in a bull that we now sojourn. As such, I suspect that seasonal charts constructed with data from only our current bull are much more relevant to gold trading today than the usual multi-decade charts.

So the feedstock data fed into the charts in this essay largely encompass only our current gold bull, which happened to be stealthily born back in April 2001. I decided to include 2000 as well since gold had already started bottoming late that year. Thus every trading day in gold between January 2000 and October 2006, the last complete month before this essay, is factored into these seasonal charts.

The calculation methodology is simple in concept. For each calendar year the daily gold price is indexed to the first day of that year at 100. Then that year’s subsequent gold movements are converted into an index meandering off of this start of 100. This process is repeated for each calendar year and then all the individual calendar-year indexed results are averaged. A big spreadsheet and thousands of formulas later, the chart below emerges.

It reveals gold’s seasonal tendencies at different times in the year for its bull market to date. Although once again I urge you not to use the sometimes-fickle seasonals as a primary indicator, they are interesting as a secondary indicator. And when primary sentiment-driven indicators and the seasonals line up, the odds start getting quite high that the existing tactical gold trend has plenty of room to run yet.

While our seasonal research at Zeal is still young, this is the most fascinating bull-only seasonal chart I have seen yet. It is exceptionally interesting due to its seasonal trend rendered above. For almost the entire year, with the exception of December, gold tends to meander upward within a seasonally-defined trend. Gold tends to rally up to seasonal resistance and then correct back down to seasonal support like clockwork. These seasonals curiously look just like a typical raw-price trend.

If you want to add gold or related positions to your portfolios, the best time seasonally is when gold is languishing near its seasonal support. This tends to happen in late March/early April, late July, and early November. Off of each of these three major seasonal buying points marked above, gold’s trio of seasonal rallies tend to launch.

Gold’s first seasonal rally from mid-March to mid-May lasts about two months and carries the Ancient Metal of Kings from around 100 indexed to 105ish, a 5% gain on average. This seasonal tendency certainly exerted itself with a vengeance this year, as gold blasted 31% higher during this period in 2006! It was the biggest single rally of this entire gold bull and it happened, interestingly, when seasonals were favorable.

After gold’s strong seasonal surge into May, it enters its seasonally-weakest time of the year during the summer. This is logical on multiple levels. Since sentiment has to get quite unbalanced to the greed side to drive the steep spring rallies, it makes sense that greed has to then be gradually bled out until fear begins to loom. There is no better antidote to greed than a price that grinds lower in a consolidation over some months. Consolidations kill greed dead, almost without fail.

In addition, summers are just a slow time for trading anyway. Kids are out of school so families go on vacations and enjoy the warm summer sun in the northern hemisphere, where almost all of the world’s most important financial markets are located. Summer is almost always a slow lethargic time in the markets with little enthusiasm, the perfect breeding ground for sideways trading and consolidations.

This seasonally-weak summer in gold takes from two to four months depending on how you slice it. Gold hits its seasonal support in late July, a little over two months after the mid-May seasonal interim high. But gold doesn’t eclipse its May highs again, around 105 indexed, until early September or so which gives the weakness a duration approaching four months. Either way, we shouldn’t enter summers with great short-term expectations for gold.

Gold’s second major seasonal rally starts in late July and runs until the end of September on average. It takes gold from around 103 indexed to nearly 108 indexed, or just under 5% higher. The timing of this rally is intriguing because gold has long had a harvest component to its seasonality. In Asian cultures, particularly India, fresh income from the August/September harvests are plowed into gold as a form of investment. We could learn a lot from the Indian farmers, as putting the surplus fruits of our labors into gold is probably the best and safest way to preserve them.

Then gold tends to correct in October, which really didn’t happen this year. Last month gold bottomed early in October and has been strong ever since. This just emphasizes the critical point that seasonals are merely tendencies and they are not strong enough to trade upon solely. It is sentiment that drives the markets over the short term, and sentiment and seasonals certainly do not have to be aligned.

Then seasonally gold is done correcting and back down to its seasonal support by early November. And it is here we enter its seasonally-strongest time of the year. On average gold rallies from early November to early February, a big three-month span. This rally is exceptionally strong too. It is the only rally of the year that breaks out well above gold’s seasonal resistance. From its 105ish start to its 114ish finish when its wraparound into January is considered, this big rally approaches 9%!

This large seasonal rally makes logical sense as well. The busiest time of the year for trading the markets is during the winter. Kids are back in school and people are working hard, so they start to refocus their attention on their portfolios. In addition to this, both the end of one year and the beginning of the next are times when people are most reflective on their investments. Most individual portfolio rebalancing seems to happen in December and January since year end triggers so much thought on the future. So it is probably natural for people to buy gold in a gold bull during this reflective period.

Obviously this is exciting now since today, in the middle of November, we are just a sixth of the way or so into the strongest seasonal gold rally of the year. If gold seasonals hold true to form this year, we should have healthy odds of seeing gold continue to rally into early February. Thus the excellent gains we have seen in gold so far in recent weeks could very well merely be the beginning. I sure hope so!

But then again, these are seasonals. They can act like helpful lighthouses that help traders navigate into profitable shores or they can act like lethal sirens that seduce traders into deadly waters swirling with adverse sentiment. Only time will tell which role they will play over the next several months. Nevertheless, since sentiment is so aligned with them today I suspect these seasonals will prove prophetic this year.

One of the biggest limitations of seasonals is that they are averages of multiple years. So a seasonal average of 105 can emerge from one year at 104 and another at 106 or one at 55 and the other at 155. In the latter case, the statistically-smoothed seasonal line betrays the extreme variance of the actual underlying data. Unfortunately gold tends to be more volatile and variable rather than less. The inset chart in the lower right above highlights this.

The inset chart is the same annually-indexed gold bull-only seasonal data, but with yellow lines rendered representing one standard deviation above and below the seasonal average. Each vertical-axis increment in this inset represents 10. So in December the first standard deviation of this gold data is so large that seasonal gold has a two-thirds chance of ending up anywhere between 98 indexed, down on the year, to 123 indexed, way up on the year. So please realize chaotic and highly variable gold data feeds its smooth seasonal average.

This next chart looks at the same raw data in a different way. Instead of indexing each calendar year starting at 100, each calendar month is indexed starting at 100. Then all the January indexes are averaged, all the Februaries, etc. The result shows the pure calendar-month tendencies of gold. There is a visual problem with this chart though that you have to keep in mind.

Each month below is a discrete unit, meant to be considered in isolation. Yet our goofy charting software insists on connecting the last day of one month with the first day of the next visually. So realize that any sharp moves at the very end of a given month are not seasonal but in reality just a gap between the end of one month and the beginning of the next that shouldn’t have been rendered. Each new month starts at 100 and is a totally independent unit.

Looking at gold seasonals this way spread across discrete calendar months tends to bolster the message of the annually-indexed averages above. Gold’s strongest calendar months seasonally mostly tend to occur between now and early February.

At best, intriguingly, the strongest months in gold seasonally all tend to witness equal gains of about 2.6% to 2.7% during the calendar month. This level is witnessed in May, September, November, and December. And early February, although it falls short, still has the next best intra-month indexed gains on average. So all things being equal, your odds of success on the long side should be the highest seasonally from now to early February as well as in May.

If you want to buy gold the weakest months are very close to the annual weakest spots in the first chart. Mid-March, late July, and mid-October tend to be the worst spots for gold seasonally when indexed monthly. This year gold bottomed in early October, just a week or so before the typical October mid-month weakness that marks a great entry point ahead of the year-end rally. And since then gold has been rallying just as seasonals expect.

Pretty interesting eh? Nevertheless, please be careful here. The standard deviations of monthly seasonals are also quite large, with one standard deviation graphed above in the inset utterly dwarfing the range of the averaged monthly-seasonal data. We are talking swings of +/-5 here above and beyond the core seasonal data which can’t even manage to hit +3. Once again the underlying gold data is highly variable before the averages smooth it.

When considered properly with all their limitations out in the open, the seasonals provide an interesting secondary perspective on some of the probabilities likely to influence a market. In gold’s case, we are entering the seasonally strongest period of the year over the next several months. If this was the only thing gold had going for it then the seasonals wouldn’t be particularly noteworthy. But since gold just completed a necessary and healthy consolidation and its sentiment is growing favorable again, this alignment is quite bullish.

At Zeal we have been redeploying into elite gold stocks since late September or so, because back then our primary pure-sentiment-driven indicators were showing that a major interim bottom was highly probable. So far they have been right and we are already up 20% to 30% on some of these new trades. As long as gold sentiment remains favorable, we plan to continue our campaign and layer in more new trades. Bullish seasonals are just the icing on the cake.

If you want to join us in our latest gold-stock campaign and mirror our new trades with your own risk capital, please subscribe to our acclaimed monthly newsletter today. With the stars lined up for gold once again for the first time in over a year we are continuing to add new positions as long as market conditions warrant. Today is a very exciting time to be a gold-stock investor and speculator!

The bottom line is the gold bull seasonals are looking very bullish over the coming months. Yes seasonals have all kinds of limitations and shouldn’t be used as primary indicators, but nevertheless they provide an encouraging secondary confirmation of a new sentiment-driven trend already in force.

With gold just coming off a major interim bottom following a healthy consolidation and gold sentiment improving, the near-term fortunes for gold look very promising regardless of seasonals. But when bullish seasonals are added to the mix, gold just looks that much better. We should be in for a very nice gold rally in the coming months!

Adam Hamilton, CPA

November 17, 2006

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