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Did Gold Break Out of Its Trend Channel?

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A substantial, multi-month "cup" from the cup-and-handle formation is clearly visible.

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Let me begin this week's essay by quoting a part of last week's update, in which I mentioned that the regular interpretation of the trend channel in gold might be misleading this time:

There's a specific phenomenon in the technical analysis that I've noticed during my observations -- when a pattern becomes "evident" so that everyone sees it and is able to act upon it, the price does exactly the opposite to what it's expected to do

There's a good reason for that to take place. Once everyone takes action on a particular signal (for instance they sell before a breakdown), there's nobody left to sell anymore, and as price fails to move decisively lower, investors buy back and fuel another rally.

In most cases it's very difficult to estimate if a pattern is "commonly known" or not, but the current trend channel is rather evident, so its reliability is a little lower.


Consequently, gold has broken above the rising trend line on Monday and hasn't move back below it so far. Therefore, it doesn't surprise me to see many messages in my e-mail inbox from investors who are out of the market and are afraid that gold will never look back and that it will keep rising in the foreseeable future.

However, this is a small clue that this isn't the case yet and that a correction is coming rather soon. The price of gold broke above its resistance, and the breakout was confirmed by a few consecutive closes above this level -- but is this enough to suggest that another strong rally will begin even without a small breather?

Let's turn to gold charts for details:


Source: StockCharts.com

The short-term resistance level, created by multiplying the distance between two previous tops by 1.618, has been hit on Wednesday. Yet, the price didn't reverse immediately. Instead, it moved to the previous resistance and verified it as a support by moving higher after touching it on an intra-day basis.

Moreover, the volume has been rising during the past two weeks, which is a confirmation of the move -- in other words, it suggests further gains in the short term, not a plunge.

Naturally, a sell-off might materialize even despite the lack of warning signs from volume, but this isn't a likely outcome. Therefore, gold might move even higher (not necessarily today) before correcting in a more meaningful way.

Before moving on to the analysis of the USD Index, I'd like to comment on the recent developments on the non-USD chart of gold (gold:UDN ratio).

UDN is the symbol for PowerShares DB US Dollar Index Bearish Fund, which moves in the exact opposite direction to the USD Index. Because the USD Index is a weighted average of the dollar's currency exchange rates with the world's most important currencies, the gold:UDN ratio means the value of gold priced in "other currencies". It trades similarly to the USD/EUR currency exchange rate.


Source: StockCharts.com
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No positions in stocks mentioned.
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