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Tuesday, September 7, 2010

Gold Chart Pattern: the bulls come roaring back

The chart pattern of gold has taken investors on a roller coaster ride of late. Plummeting down at breathtaking speed, only to shoot up like a rocket the very next minute.

At the time of writing this post, gold price is in the ‘shoot up like a rocket’ mode and about to test its recent high of 1261. That would mean a $100 (8.5%) rise in a month’s time! Can it go even higher? Sure it can. Should you be buying now? No.

Why not? We need to look at the 1 year closing chart pattern of gold for the answer:


The smoothly rising 200 day SMA is a clear indication that the gold chart is in a strong bull market. The 14 day SMA hasn’t even come close to touching the long-term average.

The recent dip to 1160 was the closest (20 points) that gold prices have come to test support from the 200 day SMA. That was a good opportunity to enter for gold investors.

When prices are near an all time high, there are two reasons one should feel cautious, and not excited.

First, there is usually a bit of selling pressure at or near new highs. Might as well wait for the likely dip to enter. The second reason is the possibility of a bearish double-top formation at a market top.

Why would there be a bearish formation in a strong bull market? In technical analysis, there are never any certainties. In any case, we won’t know for sure unless a double-top actually forms. So at this stage, let me put it down to an educated guess.

For those interested in performing a little experiment, take a sheet of paper and line up one (smooth) edge with the progressively higher bottoms made by the gold chart from Mar ‘10 till Jun ‘10. What do you see?

There are four bottoms that touch the edge of the paper before the high of 1261 was made. The edge of the paper is the up trend line, which wasn’t ‘broken’ till after the all-time high was touched. That is the way trend lines are supposed to work in a bull market.

Now the interesting part. Please repeat the experiment by lining up one edge of the sheet of paper with the bottom touched in end Jul ‘10 and the next two higher bottoms in Aug ‘10. Notice any difference?

The recent top in Sep ‘10 disappears below the sheet! The up trend line has been ‘broken’, before the gold chart tries to test the previous high. Does this prove anything? No. It only shows that the up trend is losing momentum.

In case gold price fails to move above the previous high of 1261, a drop below the 14 day SMA will be the first warning of a change of trend. But the confirmation of a ‘double-top’ will come only if the price drops below the previous low of 1160. Should that happen, gold price will also fall below the 200 day SMA.

Such bearish scenarios may not transpire at all, and the gold chart may scale new heights soon – like many experts are suggesting. But forewarned is forearmed.

Another interesting bit of observation. If you compare the Dow Jones (DJIA) index chart pattern with the gold chart pattern over the past four months, an inverse relationship is visible. When the Dow moves up, gold price falls, and when the Dow drops, gold price rises.


Titu said...

Hello Sir,

I think that gold has risen due to global uncertainties and risk aversion, and in future if global markets are going to face uncertainties and risk aversion, then gold will rise again.

Whatever happens in 2008 if such situation arises again gold will rise; it may be dollar weakening, global economic uncertainties, risk aversion or liquidity pushing asset prices.

And I think 2008 will get repeated but not that severally.

Please guide if my view is wrong.


Subhankar said...

Those are the 'rational' reasons, Titu.

But gold prices have also risen due to rampant speculation under the guise of rational reasons. Somehow, I get the feeling that the outcome of the oil speculation a couple of years ago may get repeated for gold.