Is Gold Losing its Luster?

The allure of gold has never been stronger in today's volatile markets. The precious metal has been glittering over the last few weeks following massive one-thousand-point swings in the stock market, pushing it through $900 an ounce from the mid-$700 level in September. Some market watchers are even calling for a spike to $2,000 in the next six months. It's no wonder the shiny stuff is sometimes called the 'world's crisis commodity'.

Gold Bars
Gold Bars

But it is now a tug of war where gold goes as the precious metal is also seen as a hedge against inflation. With the global economy sitting on the brink of a recession, falling prices could take a toll on the metal's luster.

Is gold really losing its shine? The charts give us some clues.

The general rule in trading and technical analysis is to keep it simple. The more complicated a chart, the greater the room for error and excuses for not taking appropriate action. The usual chart display for COMEX Gold shows exceptional volatility and a web of four trend lines.

The central trend line starts from the low in July 2005. Gold price activity is defined by a parallel upper and lower trend line. Then we add a new trend line to take into account the recent lows. Add another support line near $780, and another long term support line near $690 and it becomes a confusing chart display.

The candlestick chart contains two essential pieces of information for analysis. The first is the increase in volatility. Weekly price ranges have increased significantly and this signals indecision.

The second is the broadening fan pattern. This is a long term signal of trend reversal. The bullish application of this pattern is seen in the Shanghai Index while the gold chart shows the bearish application of the pattern.

Shifting to indicator analysis using a Guppy Multiple Moving Averages (GMMA) display develops a clearer picture of the trend behaviour. The red group of moving averages gives the implied activity of investors. This group has turned down and begun to develop compression. This suggests long term investors are becoming sellers. They use the rise in price as an opportunity to lock in profits.

guppy gold oct21.jpg

The group of blue averages indicates the behaviour of traders. There are three important features. First, this group has dropped below the long term GMMA for the first time since December 2003. This signals a very significant change in relationships from bullish to substantial bearish pressure.

Second, the rally rebounds driven by traders have become weaker. This is verified on the GMMA where a downtrend line is drawn from the March to the October peaks on the short-term GMMA.

Third, the most recent rally rebound was unable to lift above the upper edge of the long-term GMMA. These are all classic end of trend signals. They are discussed in more detail in my book Trend Trading.

Traders who apply Relative Strength Index (RSI) divergence analysis will note the divergence signal starting November 2007 and confirmed in March 2008. Current RSI activity acts as a confirmation signal of developing bearish strength.

The trend analysis suggests there is a lower probability the long term gold trend will continue upwards. The pattern of volatility in price indicates traders can anticipate some fast rallies towards resistance near $920 and rapid retreats towards support near $780. However, these price moves develop within the environment of stronger downward pressure. The key confirmation of bearish pressure is two consecutive weekly closes below support at $780. This sets a longer term support target near $690.

Bullish success is indicated with two consecutive weekly closes above resistance near $920.

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