Gold Market Update

originally published December 27th, 2009

The technical picture for gold has brightened considerably over the past week, despite the price having continued to drop and the apparent failure of an uptrend. The reasons for this are to be found in the price action of gold itself and in what has been going on elsewhere at the same time.

On the 1-year chart we can see how the current downtrend continued to take the price lower early in the week before it bounced back late in the week as the market wound down for the Christmas holiday. Failure of the parabolic uptrend channel was followed by a breach of the parallel uptrend channel, as we had expected, however, applying our 3% rule we see that gold did not drop below our general stop for the sector at $1067 before it bounced above an important support level. With gold just above this support and now oversold on its MACD and various other shorter-term indicators, and still in the vicinity of its rising 50-day moving average, this is a good place for it to turn up. With respect to the trendline failure we should note that it is a favorite trick of Big Money to execute trendline failures in order to run people out of their positions before prices reverse sharply in the other direction. This is why we have our 3% rule. To see why last week's action was bullish we will examine the downtrend from early this month in detail on a 3-month chart.

On our 3-month chart we can see that while gold did continue to drop early last week as expected, the rate of decline decelerated, and Tuesday's action was most interesting. There was a further sharp drop on Tuesday morning that was followed by a distinctive V-shaped recovery that confirmed our suspicion that the downtrend in gold from early in the month has been taking the form of a bullish Falling Wedge, the lower boundary of which held on Tuesday as the price bounced back into the channel. This observation prompted a buy alert for gold and the PM sector in general on Tuesday afternoon on the site, issued about 4 hours after the low, after which gold recovered so that it is now on the point of breaking out upside from the Falling Wedge, an event which, should it occur as looks likely, can be expected to trigger a sharp rally. In addition to the bullish Wedge, we can see that the downtrend has taken the form of a clear 3-wave zigzag, which is the classic countertrend reaction waveform whose appearance suggests that this is indeed just a reaction which has now run its course. However, while a sharp rally back towards the highs now looks likely, we should not lose sight of the fact that the heavy reaction of the past month involving trendline breaks has shocked the market, and it will probably take some time for sentiment to recover. It therefore looks likely that some kind of trading range, probably taking the form of a sizeable Triangle, will form before the market has pulled itself together sufficiently to break out new highs. Possible boundaries for such a Triangle have been drawn on the 1-year chart above, which are only intended as a rough guide. Note that in the event of a rally back up towards the highs soon our $1067 exit point, which in any case was and is rising with the trendlines, will quickly become meaningless in the event that gold slopes off sideways into a trading range for a while.

There have been significant developments elsewhere over the past week or two that are regarded as positive for the Precious Metals complex. One is the startling resilience of the Venture Comp Index (CDNX) whose chart is shown below. In the face of a reaction in gold that was quite heavy the CDNX hardly flinched, and it rallied significantly late last week so that it is already pushing new highs. Given that this index has served as an important lead indicator for gold in the past, this action is regarded as most auspicious for the sector.

Another intriguing development of the past week or so has been the breakout by the S&P500 index above its massive "Distribution Dome" shown on the 1-year chart below. This Dome is of immense importance as it has acted as a defining and limiting feature since soon after the stockmarket rally began way back last March. Before we draw any conclusions however we should take careful note that this breakout is still marginal and has occurred on light volume just ahead of the holidays. The move is thus not to be trusted - yet - as it could be followed by a violent reversal as tax selling kicks in in the New Year. However, should the market advance away from the Dome in the New Year it will signal that a significant new uptrend has begun, which will have major implications for all markets, as it will be a sign that a new round of QE (Quantitative Easing) or money creation is in the pipeline. For those who do not know QE is the new miracle solution to all economic problems - liquidity, budget or debt problems are solved "at a stroke" by the creation of massive tranches of extra cash. There is unfortunately a downside to QE - inflation, which is of course good news for most hard asset prices, especially gold and silver.