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Tuesday, August 10, 2010

Gold Chart Pattern: is the correction over, or is this the start of a bigger fall?

Before I get into the gory details of the gold chart pattern and whether the correction in gold prices is over or not, please allow me a little digression into the probable reasons why any one would buy gold at a price of 1200 dollars an ounce (well, 1193 at the time of writing this post).

Some buy gold ornaments as gifts for their loved ones on special occasions – like marriages and anniversaries. They could as well have gifted a watch or a pen or an iPhone. The reason behind the gift wasn’t ‘investment’, but the joy of sharing.

In the ‘investment’ category are reasons like ‘portfolio diversification’, ‘inflation hedge’, ‘currency hedge’ and ‘crisis hedge’. Are these reasons logical or emotional?

Having some gold in one’s investment portfolio may make sense, if the percentage allocation is about 5% or so. But remember that it doesn’t provide any returns whatsoever. No dividends and no interest. Buying a couple of balanced funds instead may be a better idea.

As per the data provided in this slightly dated but very interesting article, gold is not much of a hedge against inflation. In fact, it is a better hedge against deflation. There is an inverse correlation between gold and the US dollar, but the correlation is weak.

What about a ‘crisis’? Like a world war, or a total collapse of the financial system? Several nations with nuclear weapons capability ensures that a world war is highly unlikely.

That leaves the possibility of a collapse of the financial system as the only reason for the recent run up in the price of gold. A flight to safety. A belief in the ‘Golden Rule’ – those who have gold will rule.

Does the fear of a financial collapse justify buying gold at 1200 dollars an ounce? I don’t think so. What do readers think?

That was a long digression. Now a look at the one year gold chart pattern:

Gold_Aug1010

In last month’s analysis, I had mentioned about possible support at the 1160 level that could provide an opportunity to enter. The gold price chart seems to have read the post and decided to humour the writer.

After twice failing in its attempts to cross above the 14 day SMA, making a bearish pattern of lower tops and bottoms, gold prices fell exactly to 1160 (just 20 points above the 200 day SMA). This time the bulls were ready. The chart spurted up above the 14 day SMA and, after a bit of hesitation, above the 1200 level.

A pullback down towards the 14 day SMA seems to be in progress now. The bulls will expect the short term average to provide support for the bull market to resume. The bears will hope that gold’s price may drop below the 14 day and the 200 day SMAs for a correction deeper than the 8% we have seen so far.

I am unable to answer the question as the gold chart doesn’t provide technical indicators for gauging market sentiment and price momentum. May be I should visit the bank and find out if the young lady there still tries to sell me gold coins at a ‘discount’ or not.

With the Dow and the European indices looking bullish, and strong corporate Q2 results, risk appetite seems to be returning to the stock markets. That doesn’t equate well with a rise in gold prices.

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