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Thursday, January 6, 2011

Gold Chart Pattern: ready for a decent correction?

A look at the 1 year gold chart pattern tells me that a bullish or a bearish signal – like beauty – is in the eyes of the beholder. For the past 10 years, gold’s price has seen a parabolic rise with only the correction in 2008 dropping it significantly below the 200 day SMA. Since then, gold prices have moved up almost vertically.

Every one and his brother-in-law is buying gold and advising others to do likewise. As a contrarian investor, one should take this as an indication that gold’s price has topped out – at least for the short-term. Has it?

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The 1 year gold chart pattern clearly indicates that the upward move in price has hit a technical road block. Since Oct ‘10, gold’s price chart has been making higher bottoms but the Nov 9 ‘10 top of 1421 hasn’t been breached on a closing basis yet (though prices did move higher on intra-day basis).

Note that the Nov ‘10 top was tested twice – on Dec 7 ‘10 and Dec 29 ‘10. That seemed to form a bullish ‘ascending triangle’ pattern (rising bottoms and a flat top) from which the likely break out is upwards. The upward break out may not happen due to several reasons. The strong performance of the US and UK stock markets over the past couple of months is one.

The Dec 29 ‘10 top of 1412 was a lower than the Dec 7 ‘10 top of 1420. The low of 1368 on Jan 5 ‘11 (yesterday) found support on the up trend line connecting the Oct ‘10 and Nov ‘10 lows. If gold’s price falls any further, it will breach the up trend line and drop below the ascending triangle. If the 1363 level (low touched on Dec 16 ‘10) is breached, a bearish pattern of lower tops and lower bottoms will form.

Most bearish of all is the ‘triple top’ pattern formed by the three tops on Nov 9, Dec 7 and Dec 29 ‘10. The pattern will get confirmed only if gold’s price drops below 1340. In which case, the price may fall to 1260. If all this sounds like ‘gloom and doom’, let me assure gold investors that it isn’t.

Corrections are normal and good for the long-term sustainability of bull markets. Gold’s price has dropped below the 14 day SMA, which is negative in the short-term. But it remains well above the rising 200 day SMA, which means there is no threat to the long-term bull market.

Existing holders can stay invested with a stop-loss at 1250 (level of the 200 day SMA). New entrants can use any dip below 1340 to accumulate.

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