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Tuesday, April 6, 2010

Should you be buying gold at current prices?

When I mention 'buying gold' I mean buying gold ETFs or a gold fund and not physical gold. During my previous analysis of the 1 year gold chart, I had noticed a possible formation of a bullish inverse head and shoulders pattern.

I had also cautioned about the previous tops at 1150 and 1212 that needed to be cleared before the bulls could regain total control. Let us first take a look at the 1 year gold chart pattern:-

Gold_Apr2010_1yr

The inverse head and shoulders turned out to be a failure as the gold chart oscillated around the 14 day SMA in a sideways consolidation pattern. The 200 day SMA continues to move up, so the advantage remains with the bulls.

How long can this consolidation continue? On the previous occasion, after the gold chart pattern reached a high of 980, it consolidated sideways in a band between 910 and 960 for 3 months from end May '09 to end Aug '09. It then broke out sharply upwards to make the high of 1212 in end Nov '09.

This time around, the sideways consolidation in a band between 1050 and 1150 has continued for almost 4 months. It would seem we are overdue for an upward breakout soon.

A look at a longer term (5 years) gold chart throws up a wholly different possibility:-

Gold_Apr2010_5yr

Note the period from around May '06 to Sept '07, soon after a new high of 720 was made. The gold chart consolidated sideways for more than 16 months between a band of 550 and 700 (ignoring the sharp spike in Dec '06) before breaking out upwards to make a new high above the 1000 mark in Mar '08.

What followed was another long period of sideways consolidation in a wider band between 700 and 1000. This time the consolidation lasted nearly 18 months before a sharp upward break out saw the gold chart pattern reach the all-time high of 1212.

So, what looked like a 3 months sideways consolidation (from May to Aug '09) in the 1 year chart was actually the tail-end of the much longer 18 months consolidation! A good reason why investors in gold should take a real long term view.

Also worth noting is that on both previous consolidation periods, the gold chart moved below the 200 day SMA and took support at the previous tops before resuming the up trend. A similar possibility opens up if the current consolidation continues longer.

Going back to our original question - if you should be buying gold at current prices or not. The answer is a definite 'maybe'. A decent point of entry would be if and when the gold chart falls below the 200 day SMA. In which case, it may drop to 1000 (the previous top).

Even if the gold chart pattern dips to 1000 and you do get in, you may have to wait a year before getting any returns. That is how long the current sideways consolidation may continue.

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