Jay O'Keefe's Investment Letters

Letter 24 
April 14, 2008

Gold, Silver and 200-Day Moving Averages

I begin today's letter with a study of gold and silver, my two most important investments.

In my opinion, the following study is one of the most important I have ever presented in these letters. Since I don't know the future, only time will reveal whether it is or not. Let's begin with a five-year chart of the secular bull market in gold.

gold Technical chart [Kitco Inc.]

The red line is the price of gold. The smother green line is the 200-day moving average. It has been amazing to me how often the 200-day moving average "defines" a secular bull market, meaning the price will fluctuate above the average, but the moving average seems to act as a magnet which draws the price back toward it time and again. Notice that every time the price of gold touched or penetrated the moving average line, it was a good time to buy gold. And the price never penetrated the moving average very far, or for very long, at least up until now.

OBSERVATION 1: If Rogers is right that we are in the fourth inning of a nine inning secular commodity bull market, then there are some good opportunities remaining in gold.

OBSERVATION 2: Having said that, our short term risk is higher because the price is far above the moving average. Any time the price rises as much as 25% above the moving average, short term risk increases. Notice what happened in the spring of 2006. Gold rose to about 725, at which point it was about 36% above its moving average¡­way ahead of its bull market as defined by its 200-day moving average. Note also that it was about 18 months later before it regained and surpassed its 2006 high of 725. Note also how steep and how fast the drop from that over-extended high occurred. This is an extremely important perspective that the long term investor in a bull market must have. I doubt the average investor is even aware of this perspective. (I certainly wasn¡¯t the first time I invested in gold in the 1970s). By the time the eighteen months required for gold to make a new high had passed, most investors probably lost patience and sold out their gold.

OBSERVATION 3: At its recent high of about 1032, gold was again well over 30% above its moving average. Its current correction should be no surprise. Consider it both normal and healthy, and use it as an opportunity to add to your gold if you don¡¯t yet have your full position. But don¡¯t buy until you have finished reading this letter.

OBSERVATION 4: How long will this correction last, and how far down will it go? I do not have the faintest idea, but I will point out that it could go below 800 and not even disturb the bull market trend. You can see that on the chart. This also is a perspective the average investor doesn¡¯t have, and gold below 800 will shake many investors out. The bull will buck many of the late comers off for any number of reasons, including borrowed money, fear of losing, bad advice, ignorance of the above chart, etc. As this is written, gold is trading at 928. I hope we get a chance to buy it in the low 800s or high 700s. I would consider it a bargain price at those levels (see more on this below).

At its recent high of 1032, gold was up 175% from its 2002 low. Keep that figure in mind, and let's look at silver, a far more promising prospect in my opinion.

Silver Technical chart [Kitco Inc.]

A lot of the same observations made about the gold chart can be made about silver. Here are some additional ones.

OBSERVATION 1: Silver is much more volatile than gold. There are both supply and demand reasons for this, as well as its lower price. Several experts estimate the above ground supply of gold to be about 5 billion ounces. Essentially all the gold that has ever been mined is still around in one of three forms, jewelry, coins and bullion bars. Experts estimate the supply of silver at about half that amount. In addition, the silver is being depleted because of its industrial uses discovered in recent years. You can see the volatility in the above chart. In 2004, silver reached a high of 8, which was 40% above its 200-day moving average, and it didn¡¯t reach a new high until almost two years later. In 2006, when gold was reaching its high, silver reached a high of 14, more than 70% above its moving average. From there it fell 30% in a few weeks. Again it was nearly two years later before it bettered that high. At its recent high of 21.5, it was about 50% above its moving average, and fell 24% in a few days. Where it will go from here, again I have no idea, but in my opinion it requires more emotional control to invest in silver than in gold. More on that below.

OBSERVATION 2: From its 2002 low, silver was up 312% at its recent high of 21.5, compared to gold's 175% increase over the same period. I believe silver is in the process of correcting its severe under-valuation relative to gold, and that this process still has a long way to go. I've discussed some of the reasons in prior letters, but I strongly recommend that you read the article entitled Believing Your Own Eyes, by Theodore Butler. Here is a link for it.


This is the reason I own 3.5 times as much silver as gold, and two of the best silver mining stocks.

OBSERVATION 3: Notice on the chart all the price peaks near 14 during 2006 and 2007. In charting language, this is called a strong resistance area, because the market labored for two years trying to break through 14. Once a strong resistance point is overcome, it tends to become a strong support area. Should the silver price continue to fall in this current correction, it should find rock-bottom support near 14. That would be a super buy point in my opinion. I have no idea whether we¡¯ll get that opportunity or not.

If I did not have my full allocation to silver, I would continue to dollar cost average in small bites until I reached it, and I would delay adding to my gold allocation until I had my full silver target position. That tells you how much more potential I believe silver has than gold. Of course, you may vary this in any way you feel convicted. Both are good values.

As to the details of dollar cost averaging, I have covered this in past letters. I would keep an eye on the above charts, and if either metal approached its 200-day moving average, I would probably finish buying my target allocations. I have no idea whether this will happen, but if it did, it could be one of the best buying opportunities we will see for a long time. 

I would avoid stocks until some obvious bargains appear. I will do my best to identify them if they do. I would also seek to hold a good cash reserve awaiting the bargains.

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"Well done, good and faithful servant; you were faithful over a few things,
I will make you ruler over many things.  Enter into the joy of your lord"
(Mt. 25:21 NKJV)

If you have not been faithful in the unrighteous mammon, who will commit to your trust to true riches?" (Lk. 16:11 NKJV)

The Apostle Paul wrote, "Now godliness with contentment is great gain. We brought nothing into the world and it is certain that neither can we take anything out. So having food and clothing we will be content with that. But those who want to get rich fall into temptation and a snare and into many foolish and harmful desires, that plunge people into ruin and loss; because the love of money is a root of all kinds of evil; in their greediness some have been led away from the faith and have impaled themselves on many distresses." (1 Tim. 6:6-10 NKJV)

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The information in these letters is the responsibility of Mr. E. Jay O'Keefe, but all your decisions are your own responsibility.

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