Expect Gold to Bounce Higher -- and Then Decline
The coming bounce does not appear large enough or sure enough to bet on, and the short-term trend now appears to be bearish.
When a roller coaster plunges, it's gut-churning, heart-racing, blood curdling, in a word -- petrifying. That's how precious metals investors must have felt Wednesday when gold plunged more than 5% to hit a low of $1,688.44 per ounce, after earlier trading as high a $1,791.49 per ounce.
On Tuesday, the day before the plunge, my firm had sent out a market alert in which we included a list of bullish and bearish factors (actually, six of them) and reiterated our suggestion to stay out of the market with short term speculative positions as we felt that the situation was too dangerous. It seems that we were a lone voice, and some of our subscribers even canceled their subscriptions, annoyed that we were saying that the situation was bearish when gold prices were going up. We can only hope for their sakes that they didn't open any long positions.
Please allow us to digress a bit. Being a lone voice suggesting a downswing is one thing, but we have just learned that those analysts who didn't see the correction coming are now blaming certain events that took place on Wednesday or even resorting to manipulation theory. We find it a bit odd. Yes, in a way, all markets are manipulated as the money supply / interest rates are subject to government control and there are indications that gold and silver markets are being manipulated, but that doesn't mean that all sharp moves (especially the "unforeseen" ones) should be viewed as resulting from price manipulation. Yes, there was some bearish news for precious metals on Wednesday, but on any given day there are multiple bullish and bearish pieces of news. Why does news sometimes affect price and sometimes not? Emotionality of investors and traders is the answer, and technical analysis (and related approaches) can help prepare you for these sudden moves. Not all of them can be predicted, but a lot of them can be, and just because other methodologies didn't allow one to see a plunge coming, doesn't mean that one should explain using manipulation. In this week's case, the markets were bound to correct based on the similarity between 2006 and now and many other technical/emotional factors that we've been writing about it in the past few weeks. Simply put, ignoring technical analysis can be costly, and we believe that explaining all sharp market moves with manipulation theory is not appropriate -- especially if they could have been reliably predicted using technical tools.
Wednesday was a tense day as the dollar rose, gold plunged, and a rally in equities came to a halt. This was accompanied by testimony of US Federal Reserve Chairman Ben Bernanke who dashed hopes for additional growth stimulus (this is one of the above-mentioned "events"). Bernanke testified that recent developments in the labor markets were "positive" and that inflation may go up "temporarily" given recent gasoline price increases. But Bernanke gave no hint of further easing. Investors had hoped the Fed would launch another round of quantitative easing, pushing cheap money into the market that would boost inflation, against which gold is a traditional hedge. Our take is that we will see more cheap money, and what we have right now is temporary smoke and mirrors.
Keep in mind that although quantitative easing is good for precious metals, so is inflation. So, if Bernanke is talking about inflation, the market could just as well have taken that to be a positive indicator for gold prices; in a way, higher gold prices represent inflation (measuring a decline of dollar's value against the true money).
The decline in gold was accompanied by a decline in stock markets a day after the Dow broke through 13,000 to hit a nearly-four-year high. And on Wednesday, the Nasdaq briefly topped 3,000 before pulling back as Bernanke's remarks took the air out of the rally. Even with the day's decline, the major indexes were able to post their strongest February in years. And even with Wednesday's decline, bullion is still up 10% this year, on track for its 12th consecutive annual gain.
Having emphasized technical analysis' role in the process of investment analysis, let's move directly to the charts. We will start with a look at the long-term gold chart (charts courtesy of http://stockcharts.com).
In the long-term gold chart we can clearly see a continuation of the self-similar pattern. Gold bottomed at the end of 2006 when it reached the 50-week moving average. Today, this moving average is still considerably below gold's recent price levels. Since the 50-week moving average is trending higher, a week or two more of declining prices should result in gold's price and the moving average meeting somewhere in the $1,650 range.
One other note concerns the RSI levels. In 2006, gold reached its bottom with the RSI level slightly below 50. Thursday's close saw an RSI level close to 54 and declining, very much on pace to possibly close in to the very level seen nearly six years ago.
The gold-to-bonds ratio chart gives us a unique insight into the similarities between 2006 and today from a perspective which is quite different from studying gold itself. This chart also provides us with similar signals and confirms the self-similar pattern.
In both time frames, we have first seen a correction (following the 2005-2006 and 2010-2011 rallies) to the 61.8% Fibonacci retracement level and then a move back up to the 38.2% level. The small moves in '06 and '12 above this line were both followed by declines. This is more or less where we are right now. In 2006, we next saw a small bounce and then a decline to the final bottom.
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