GOLD BREAKS OUT TO NEW HIGH FOR THE MONTH -- BULLION HAS HELD UP BETTER THAN STOCKS AND OTHER COMMODITIES -- SOME OF THE GOLD BUYING MAY BE TIED TO FEAR OF DEFLATION -- TODAY'S HIGHER MARKET CLOSE KEEPS 2002 LOWS INTACT

GOLD HITS MONTHLY HIGH ... I wrote in yesterday's message that recent fears of deflation were giving a big boost to Treasury bonds. I also wrote that, in a deflationary environment, stocks and commodities usually fall together and become closely correlated. That's certainly been the case since mid-year. There's one other market, however, that can also benefit from deflation and that market is gold. While I was rewriting my book on intermarket analysis in 2003, talk of deflation was rampant. As a result, I researched the last period of deflation that we had experienced from 1929 to 1932. During that difficult period, stocks and commodities plunged. Only two markets rose. Bonds and gold stocks. Since gold was fixed at a set price in the 1930s, it stayed flat. There are at least two reasons why gold does well during deflation. One is that gold often attracts money when stocks are in a bear market. Another is that gold thrives in an environment of falling interest rates. I point that out because of the mistaken notion that gold only works as a hedge against inflation. It can also act as a hedge against deflation. And that may explain why gold has suddenly started to jump.

Chart 1

Chart 2

GOLD HITS MONTHLY HIGH ... Chart 1 shows the streetTracks Gold ETF (GLD) jumping the equivalent of $52 today. In so doing, it has broken out of its recent consolidation pattern. Although it remains well below its October high, its short-term trend has turned up. The relative strength ratio below Chart 1 shows that gold has done much better than stocks since the start of September (gold has lost -3.5% versus -41% for the S&P). Chart 2 shows the Market Vectors Gold Miners ETF (GDX) jumping 26% today. Its chart pattern isn't nearly as strong as that of bullion. The relative strength line below Chart 2, however, shows gold stocks starting to do better than the S&P 500 over the last month. Gold has also held up much better than other commodities. From its peak at midyear, bullion has lost -19% versus a -50% drop in the CRB Index and -64% loss in crude oil. Chart 3 plots the relative performance of gold (blue line) and crude oil (red line) versus the CRB Index (the flat black line). The chart shows crude doing much worse than most commodities and gold doing much better. That's because gold is more than just another commodity. It's also viewed as an alternate currency (at time when most foreign currencies are falling) and an alternative to a weak stock market. One big factor working against gold is the rising U.S. Dollar. Today's upturn in gold may be hinting that the dollar is due for some profit-taking. Even with that caveat, investors looking for some alternative to Treasury bonds or cash might want to consider gold as a possibility. If you choose to do that, I'd recommend the commodity (GLD) over gold stocks (GDX).

Chart 3

WILSHIRE 5000 STILL TESTING 2002 LOW... In chartwork, the test of an previous low is very important. That's especially true if that previous low is the bottom of the last bear market that ended in October 2002. Previous bottoms often act as a support level below the market. If that low is decisively broken, the chart pattern turns more negative. The S&P 500 closed below its 2002 intra-day low at 768 yesterday (although today's 47 point (+6.3%) jump to 800 puts it back above that support level for the week). All of the other major market indexes remain above that potential support level. In choosing a market index to represent the U.S. stock market, the Dow Jones Wilshire 5000 Composite Index is the broadest measure that we have. So it's worth keeping an eye on. The monthly bars in Chart 4 show the WLSH still in the process of testing its 2002 intra-day bottom at 7273. [It rose 454 points (+6%) today to close at 7926]. Keep in mind that a downside violation during a month isn't as important as where the market closes at the end of the month. That's still a week away. At this week's end the 2002 lows are still holding.

Chart 4