Is Recent Rally in Gold a Sign of Strength?

By Przemyslaw Radomski, CFA  SEP 20, 2013 11:20 AM

The downward trend in gold remains in place even though we could see some short-term strength soon..

 


According to Reuters, gold is often seen as an inflation hedge (while it is really a system hedge in my firm's opinion) and this safe-haven investment, has fallen nearly 20% this year on fears of an end to easy central bank money, which had propelled it to record highs in 2011.
 
On Wednesday, after the Fed said it would stick to its stimulus plan for now, the yellow metal gained more than 4%, leading the rally in commodities. Yesterday, gold rose to a new one-week high and extended the previous session's rally, lifted by technical buying and short-covering.
 
What happened with the US dollar?
 
The USD Index lost over 1% and declined slightly above the 80 level on Wednesday. It’s worth noting that this is its biggest one-day slide in more than two months. Additionally, we saw such low values in February, well before Fed Chief Ben Bernanke first floated the idea of tapering the stimulus back in May.
 
Today, gold slipped a bit, but is still trading around $1,360 an ounce. Can the yellow metal climb higher in the near term? Will the dollar recover quickly? Can we find any guidance in the charts?
 
In today’s essay we’ll examine the US Dollar Index (from many perspectives and the long-term gold chart to see if there’s anything on the horizon that could drive gold prices higher or lower in the near future). We’ll start with the USD Index very long-term chart to put the following gold chart into perspective (charts courtesy of http://stockcharts.com).
 

 
The situation in the long-term chart has changed (for the first time in several months), but the most important thing didn’t change. The long-term breakout above the declining long-term support line was not invalidated, even though the USD dropped heavily on Wednesday.
 
However, since the medium-term breakdown (below the support line marked with red) is visible from this perspective, we could see some short-term weakness anyway. Still, it seems that the long-term support line will stop the decline, so from the long-term perspective, it seems that the downside is quite limited.
 
Now, let’s examine the weekly chart.
 

 
On the above chart, we see the breakdown more clearly. The breakdown is unconfirmed at this point, and we could still see a reversal back above the previously-broken support/resistance line. It would be a powerful bullish signal, but it seems more likely that we will see another move lower first. This is due to the size of Wednesday’s move without a visible intra-day pullback.
 
The target area is quite unclear because of the multiple support lines, including the long-term support line seen on the previous chart. It seems that we could see the US Dollar Index in the 78-79 range before the bottom is in.
 
Again the exact price target is unclear.
 
Let’s check the short-term outlook.
 

 
On the short-term chart, we see that the target area is close to the 79 level. The present cyclical turning point makes the situation extreme and difficult to trade as we could see a powerful pullback immediately even if the target area isn’t reached.
 
Additionally, please note that even though the USD Index has declined heavily in September, we also have gold visibly lower than it was at the beginning of the month.
 
Is another move lower on a very short-term basis likely? It is -- based on the True Seasonals pattern that has been working very well in the past few months.
 
Let’s take a closer look at my firm's new tool.
 

 
Please note that we saw a visible decline prior to the first part of August after which we saw an upswing which lasted until early September. This has been followed by a significant decline, which is precisely what the True Seasonal patterns were suggesting.
 
Right now, they are suggesting another small move lower in the final part of this month.

Taking the previously mentioned support levels into account, it seems that the move lower could be more significant, but it will be approximately in tune with the True Seasonals pattern.
 
Please note that the quality of the prediction (green line in the lower part of the above chart) declines in the final part of the month, which means that a deviation (in the form of a bigger decline) is not unlikely.
 
Consequently, even though the direct impact that the USD Index is likely to have on gold is rather unclear at this time, it seems more likely than not that the impact will be bullish in the very near term (in the next several days).
 
Now that we know the current situation in the US currency and the True Seasonal patterns’ suggestions on future movements in the dollar, let's find out what happened during the recent days and check the current situation in gold.
 

Click to enlarge
 
On the long-term gold chart, we see that Wednesday’s rally was not as bullish as it seemed at first sight. In spite of the strong daily upward move, which pushed gold above $1,360, the situation hasn’t changed much from this perspective.
 
As you see on the above chart, gold verified the breakdown below the long-term resistance line created by the July 2005 and the October 2008 bottoms (taking intraday bottoms into account). At this point, it’s worth noting that there was an invalidation of the breakout above the 38.2% Fibonacci retracement level based on the September 2012 - June 2013 decline earlier this month. This was a bearish sign.
 
From this point of view, it seems that even if gold increases once again in the coming days and reaches the above-mentioned levels once again, the medium-term outlook will continue to be bearish.
 
Please note that in 2008, when gold moved higher before plunging for the final time, there were several intra-week attempts to move higher after which gold finally declined. Therefore, a double top pattern should not surprise us here. The same goes for a triple top.
 
Summing up, on Wednesday, we saw a substantial price move on charts of gold and the dollar. However, these moves were significant only on a very short-term basis. Examination of the above charts reveals that they didn’t change the long-term and the medium-term tendencies. Despite Wednesday’s strength, the downward trend in gold remains in place even though we could see some short-term strength shortly. Taking into account the long-term breakout in the US dollar, the long-term outlook for the USD Index remains bullish, even though we could see additional weakness in the very short term., as indicated i.a. by the True Seasonals charts.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
No positions in stocks mentioned.

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