Turn off the lights and you can see the gold bugs glittering. The rapid rise in the gold price driven by Indian central bank buying appears to confirm their wildest dreams.
Gold is going to $2,000 or even beyond they believe. It’s the Klondike gold rush over again. Its easy to get carried away by the enthusiasm but the gold chart suggests a need for greater caution.
The gold price is influenced by four factors.
The global financial crisis created a climate of fear. Gold first reached $1,000 in 2008 March when world markets were collapsing. Then the gold price retreated. There was a low correlation between the price of gold and the increasing problems of the global economy. Gold reached $1,00 again in 2009 September when the global market recovery was well established. This suggests fear is not the driving force in the gold price.
2. Strength of the US Dollar
The strength or weakness of the US dollar is a strong influence on the gold price. When the US dollar weakens there is a move into gold and this helps drive the price. The US dollar Index chart shows a steady decline in the US dollar starting 2009 March. Gold also fell from $1,000 to $850 during this period. Gold also rose from $850 to $1,000 and higher during this period. The link between gold and the US dollar is not as well defined as many people believe.
3. Central Bank Buying or Selling
The India central bank purchased gold, driving the price to new all time highs at $1,087. This buying created a short lived rally. The uptrend pressure continues because many people believe the China central bank will also buy gold in the near future. If this develops then we will see another short term rally in the gold price. Transferring gold from the International Monetary Fund to sovereign central banks does not change the demand and supply equation. It creates a short term influence on price but it does not sustain the trend.
4. Jewelry Demand
Jewelry demand is seasonal. Many believe that Indian gold Jewelry demand increases during particular festival periods. Its certainly true, but the influence on price is difficult to see on the price chart. Jewelry demand for gold is increasing at a stable and reliable rate. It is not enough to strongly influence the price behavior of gold.
The gold price is mainly set by psychological factors and these are observed in the gold chart.
The broad trading band between $920 and $1,000 provides the method to set the upside targets for gold. The first upside target is $1,080. This has been achieved. The next upside target is $1,160. The longer term target is near $1,240. These targets are calculated using trading band projections.
There is a high probability the price will consolidate near the $1,080 level simply because the Indian central bank buying has created a temporary support level for the price. Any announcement by the China central bank regarding its intention not to buy gold will expose the weakness in this support floor and price could quickly fall to $1,000 or below. Any indication the China central bank is buying gold will rapidly move the price towards $1,160.
The slope of the gold mountain is steep. It’s a fast ride up, but the slippery down slope is an even faster ride down. This is a traders' market and traders take their signals from the chart.
In any gold rush, it's always useful to remember that apart from the lucky few, it’s the associated industries that make the real money from the gold rush. It’s the suppliers of pick sand shovels, or steel for the mine pit heads and food for the miners that go on to build solid and sustainable businesses. In this gold rush, the way to collect a better profit is from associated companies and trading instruments.
Daryl Guppy will explore some of these methods in more detail at the Gold Trading master class in Singapore on Saturday November 7.
If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.
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