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Reading gold – double bottom or support rebound?

AP

Worries about weak economic data in the U.S. and China have seen gold gather pace, with bullion rising to a three-and-a-half month high on Monday after posting its best weekly gain since August last week. However, with sentiment towards the yellow metal mixed following last year's dismal performance charts could provide some guidance.

The NYMEX Gold chart appears to have formed a classic double bottom pattern near $1,180, a level that has been tested three times.

(Read more: Gold's rally may struggle towards $1,350)

However, there are two significant problems with calling this a double-bottom pattern. The first is that double-bottom patterns are found at the end of prolonged downtrends and usually appear near long-term historical lows. Not so with gold; on a monthly chart, the $1,180 level appears in the upper third of the long-term gold uptrend that started near $600 in 2006.

The second problem is that a double bottom usually forms on a historical support level. The historical support level for gold is near $1,150.

These problems are important because the analysis of a double-bottom pattern and its outcomes is different from the analysis and outcomes of a support level rebound pattern.

The double-bottom pattern is a trend change signal. The height of the pattern from $1,180 to $1,433 is measured; this is $253. This value is added to the peak of the double bottom pattern, which gives a breakout trend target near $1,686. Clearly, achieving this target level would require a significant change to the downtrend.

(Read more: This will drop gold to $1000: Credit Suisse pro)

Investors who use this double-bottom analysis will buy the current rally, ignoring any price retracement activity because they believe the gold breakout is part of a new long-term uptrend.

The support level rebound pattern is a temporary rally within the downtrend environment. It shows a weakening of the downtrend, but does not signal a trend change. It signals a shorter term long-side trade where traders take profits as the resistance level is reached.

On the gold chart, the resistance level is near the upper edge of the long-term group of moving averages in the Guppy Multiple Moving Average indicator. The value of the upper edge of these averages is near $1,400. This is also near the main peak of the August 2013 rally in gold. The $1,400 level is also a resistance level in December 2010. The $1,400 level is a strong resistance feature on the gold chart.

(Read more: Is China using gold to internationalize the yuan?)

Investors who use this support-rebound analysis will sell gold as it moves close to the $1,400 resistance level. They will anticipate a continuation of the downtrend and watch for another test of support near $1,180.

Identifying the correct chart pattern helps to determine the correct investment and trading tactics. Our analysis suggests this is a support-rebound pattern.

Disclosure: The writer holds an open position in the S&P Asia 50 Exchange Traded Fund.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – www.guppytraders.com. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

  • Daryl Guppy is an independent technical analyst who appears frequently on CNBC Asia.

Asia Economy