Gold Market Update
Originally published December 13th, 2009.
The last update posted on the 29th November called a top in gold, which occurred just a few days later. This was actually quite easy to do given the overbought extreme that then existed and the fervour of bullishness spilling over into the mainstream financial media. Gold has since reacted back heavily and our task now is to decide whether this is just a reaction in an ongoing and possibly still accelerating uptrend, or whether it marks an intermediate top, or worse the onset of a full-blown bearmarket.
The easiest way to be popular in this business is to tell people what they want to hear. Goldbugs fall into this category. They want to be told that gold is going up, and that any downturn is just a correction and another buying opportunity. They have a special class of writers catering to their needs, known as Permabulls. The Permabulls have their bullish arguments, which are pretty convincing it must be said, sometimes with generous helpings of conspiracy theories to spice things up, which they repeat at regular intervals, and their targets at $1500 or $3000 or whatever. In recent weeks the permabulls have been basking in a glory of adulation and have practically been carried around in sedan chairs by their acolytes. We don't cater to this class of investor, except coincidentally on those occasions when we have good reason to be raving bullish too - so if you are a goldbug, who wants to be told that gold is going roaring up, you are advised to click out of this article now. Our analysis is aimed at pure traders - those who don't care whether the market is moving up, down or sideways as long as they are on the right side of the trade. Remember that you can make money even in a sideways trading market by playing the range or writing options.
So what's going on now - is that it? - has gold topped out already? There is a very wide range of opinions out there on this topic and quite often the investor is left feeling even more befuddled after reading them all than he was before he started. For instance, we have Elliot waver Ron Rosen, whose articles appear on Kitco, who is very bearish on gold over the medium-term, predicting that gold will collapse back to $640. It is hard to take him seriously though because he has been saying the same thing since before gold broke out to embark on its recent strong uptrend. At the other end of the scale we have gold superbull "Fractal Dave" whose articles also appear on Kitco, who is predicting a spectacular ramp by gold, with an objective at $1420 next March, en route to a much higher target in 2011. So far he has been right but even he is calling for gold to rest in a triangular pattern here for perhaps a few weeks before the advance resumes. Then we have Bob Moriarty of 321gold, who has a good nose for market extremes, and called the recent top in gold a shade too early as the writer did, who is now believed to be looking for a significant reaction. Next, Adam Hamilton, who is right most of the time, even if his essays take an afternoon to read, is looking for a hefty reaction in the broad stockmarket on the grounds that it has had a long, uninterrupted rise, and also a reaction in the PM sector. Finally and of course most importantly we have Maund himself, looking for a potential parabolic advance in the PM sector fuelled by a suicidal attempt to stave off powerful depressionary forces by manufacturing money to maintain liquidity and paper over the cracks, but keenly aware that the situation is now dangerously unstable and growing more so by the day, so that a major catalyst could trigger a deflationary implosion at any time - like last year, only worse, which could result in Ron Rosen's dire predictions coming true. This is why we ride the beast, but keep a close eye on the position of the exits, and why we take so seriously developments like the breakout in the dollar last week, and during high risk periods like the current one resulting from the dollar breakout we step aside and await developments.
While we were looking for a reaction in gold in the last update, we were not, at that stage, expecting it to be any more than that. There was considered to be a high probability that gold would react back towards, or to, its parabolic uptrend shown on the 1-year chart below, and then turn up again to commence another upleg. Now, however, the latest evidence - in particular the convincing dollar breakout, which we earlier considered likely, is suggesting that gold could be in for a more prolonged decline that will likely take it back at least to the top of the recent 20-month consolidation pattern, i.e. to the $1030 - $1050 area, and if we see another deflationary scare it could of course drop to considerably lower levels.
A background bearish factor that we have not made enough of in the recent past is the failure of both silver and PM stocks to confirm gold's breakout and race to new highs. This was because we expected to them to start playing catchup before gold peaked, but it didn't happen. Neither broke out to new highs - instead silver appears to be completing a bearish Rising Wedge and PM stocks may be forming a Double Top. This is bearish. The next bearish factor that we can see on the gold chart is that gold plunged back following a "throwover breakout" out of its rising uptrend channel - such breakouts often lead to failure and reversal as they are a symptom of an over-excited market close to burnout. While there is no volume shown on this gold chart, the volume pattern in SPDR Gold Trust, whose movements normally track gold closely, is powerfully bearish as we can see below. Once the turn came there was an all-out stampede for the exits, with GLD dropping back on persistent very heavy volume which suggests that it, and gold as well unless there is "something going on" in GLD, is destined to drop to considerably lower levels.
Finally, we had a convincing breakout by the dollar from a bullish Falling Wedge following a long downtrend. In the last update it was stated that while this might seem impossible on fundamental grounds it could happen anyway like last year, for reasons that later become apparent. It would appear that while the dollar's fundamentals are awful, those for the euro are even worse, with Greece getting a ratings downgrade or close to it, and Britain close to the rocks - in these extreme circumstances the dollar could wind up being the best of a bad bunch. Whatever, the dollar breakout is seriously bad news for gold, especially as it portends a rise in the dollar index perhaps as far as the 90 area, which could easily happen if there is another deflationary scare.
Fortunately for traders in these difficult times we have clear parameters, for although the latest evidence suggests that gold is going to break lower, the uptrend has not failed until the parabolic support line, and the trend channel support just beneath it are breached. Until that happens there is a chance that the uptrend will resume. However a clear breach of these support lines will be viewed as a general sell signal. Before closing, traders should note the short-term oversold extreme of the MACD histogram on the gold chart, suggesting that a bounce is likely soon even if gold goes on to break down.
Below is the 6-month chart for the dollar index included in the last update on which you can see the technical conditions described that led to the dollar breakout.
The situation as we went into the close of 2008 was very different. At that time we were on the verge of steep declines in both the dollar and Treasuries. The article Bye bye dollar, bye bye Treasuries correctly predicted both. What was rather curious though is that after rapidly plunging towards our target zone the dollar rallied back up again to exceed its high of November '08 before reversing into this year's severe decline while Treasuries briefly rallied higher before reversing into a severe multi-month decline.