Precious Metals Look Likely to Rally
The behavior of gold prices indicates a pullback first.
In a previous essay, I mentioned that although it wasn't clearly visible in the past weeks, looking at the charts with the RSI and stochastic readings in mind, silver's historical cyclical tendencies point to a downturn. This decline could be easily triggered by a downturn on the general stock market.
However, the main stock indices didn't move lower recently -- instead they moved above their January 2010 high. Please note that the breakout hasn't been confirmed by all indices, so the risk of a downturn is still not low at this point.
Given the high correlation between stocks and the PM sector, this is generally a bullish factor, but caution is necessary in the short run -- especially given the high level of similarity between the situation in the gold market in August 2009 and the one that we have today. Let's take a look at the long-term chart (charts courtesy of http://stockcharts.com) for details.
Previously, the following was written:
(…) the situation on the gold market is still self-similar also in the short run. It appears that the RSI Indicator moved has formed a high around the 60 level, just like it was the case in early August 2009, after which gold prices moved lower for about two weeks. Since the current move is still very similar to what we've seen in the middle of 2009, we might see some kind of consolidation here -- perhaps two to three weeks of lower prices.
This is precisely what we've seen this week -- gold moved lower along with the RSI and Stochastic indicators. Please note that two to three weeks of consolidation was mentioned, and so far we've seen only one week of the corrective action, which suggests that caution is still necessary. The bullish analogy is that when the previous correction (August 2009) was completed, gold surged very high. Still, as mentioned earlier, much depends on the general stock market.
The short-term chart provides us with details:
The red ellipses on the long- and short-term charts mark the self-similarity on the gold market, and the vertical dashed line shows where "we are today" if the situation is to repeat itself so closely as was the case in the past several days. Please note that the analogy doesn't only cover the price itself, but it's also present in the RSI indicator, and -- what's very interesting -- gold's performance relative to the US dollar (as seen on the last chart.) It currently suggests that the recent small rally was just a pause within the two-to-three-week correction, and thus another small move lower is to be expected.
Please note that during the first half of August 2009, gold declined along with the US dollar, however once the negative correlation returned -- in the second half of August -- it was a sign that "something is in the works." Soon after that there was a confirmation in the form of a big rally on strong volume, and the massive upleg begun. Taking the historical performance into account, once I see that the negative correlation between gold and the USD Index has returned, I might consider it as a "get-ready-to-buy" signal.
Speaking of the US dollar, let's take a look on the price of gold from the non-USD perspective. UDN is the symbol for PowerShares DB US Dollar Index Bearish Fund, which moves in the exact opposite direction to the USD Index. Since the USD Index is a weighted average of dollar's currency exchange rates with world's most important currencies, the gold:UDN ratio means the value of gold priced in "other currencies."
The above chart is generally bullish in the long-term, as the trend remains up, but it doesn't provide us with a specific trading signal at this point. Still, it shows that the price of gold isn't at a support level at this point. This means that a move lower from here is possible.
Summing up, based on how gold prices have behaved as measured by the Gold ETF (GLD), it points to a further pullback after which precious metals are likely to rally strongly. During the similar situation in the past the stochastic, RSI and price were all aligned this way and the prices retreated back to make another short-term bottom before returning back to its uptrend. Still, much depends on how the situation resolves on the general stock market.
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