Gold: The Correction is Only Beginning

In the second half of this article we’ll look at the charts of gold, and I’ll give the supportive technical evidence why I believe the downside action in gold has just begun; with much more trouble ahead for the precious metal.

First: “The story behind the charts.”

I heard a commercial on investing in gold on the radio the other day that said, “… Gold is a hedge against inflation and deflation.”  The concept that gold is a hedge against deflation comes from the time of the Great Depression, when a huge rally in the stock Homestake mining saw the price gain over 500%. That happened, however, after its discovery of high-quality grades of ore; giving it a great cost advantage. This was a unique situation. Dispelling that myth, during the‘30s, most other gold investments dropped in value, as deflation actually took a huge toll on those stocks.

I was trading in 1980 and participated in that huge bull market and subsequent crash in gold and silver (and the stock market). Even then, in a gold market that made a top that lasted for nearly three decades, there was not the level of touting of precious metals as I have heard this past year; “Gold $2200, $2500, $5000!?! It’s seemingly on every talk TV and radio station; liberal or conservative.

The rally in gold over the past several years has come from a flight out currencies, as the U.S. has as created money for bailout programs and quantitative easing (QE1 and QE2). The European situation added fuel, as investors saw a similar condition there as in U.S. since 2008, with European central banks needing to print money for bailouts of European financial institutions. This has been very frightening to investors. And with the gold market soaring and gold being so heavily peddled in the media as the investment for all market situations,  those who wanted to own gold as an investment or a hedge, or have been afraid to miss the coming “gigantic move”, chased it up to unreasonable levels. And, as always happens when there is exuberant market psychology; the hook was set.

The past couple of weeks have brought back a taste of reality to gold investors, seeing the metal collapse over $280 from its peak. And the sense that gold is a safe haven for all periods of distress is proving to be an illusion.

I wrote in my Green Faucet article in October, 2010 “Making Sense of the Markets” that in the collapse of 2008, it had been estimated that at worst levels, total asset destruction, world-wide, in the financial markets and real estate combined, had been nearly $70 trillion. Today, many “euro zone” countries are in very bad trouble. The coming default of sovereign debt of Greece and possibly Italy, and weakened condition of the financial institutions that have invested in this bad debt, has made it apparent that the worldwide deflationary pressures of the past decade remain in force. As in 2008, a substantial loss of the value of assets is creating huge demand for liquidity.

As you see in all of the financial and commodity markets, the scramble for cash is causing selling in nearly everything; including the so-called safe haven of gold. And in an odd paradox, it’s pushing investors into the US dollar; the best of all evils.

If you think there has been inflation supporting the price of gold, look at the CRB, down 20% since May. Or look at treasury yields, with 10-year yields at 1.8%.  That can’t happen if there is really inflation in the pipeline. My 37 years of trading tells me that bond market simply would not allow it. The deflationary forces are real and huge.

It is so laughable is that Bernanke and the Fed believed you can reflate the massive destruction of wealth that has occurred in this country, and solve the associated employment problems, with a couple trillion in stimulus. All they do is enhance the perception that there is a dire situation out there; one that they’re really not willing to be honest about, and that they are completely out of any palatable choices to affect the economy. The real answer is the unpalatable one; letting the economy clear itself through recession and failures. But that’s another whole article.

So with investors “all-in” in gold and the feeble and misguided actions of the FOMC, with its “twist” program, moving $400 billion of its treasury holdings further out the curve, there was nothing left to support gold and other precious metals, bringing this week’s collapse.

So with gold having traded up to over $1900 an ounce and down to last week’s closing price of around $1660, what’s next? That brings me to the charts.

The first chart below is a daily of Gold. This chart has some great information. First, notice that this chart is an interesting version of candle sticks. The “Heikin Ashi” is a chart that averages the previous four bars. So it helps take the noise out of the market and identifies if a trend is remains in force.  The rally from July, which went hyperbolic, essentially, never gave any negative warnings; a day that went red followed by a day with a lower low. Also notice how the rally followed the sharply rising 13-day moving average; another great bullish signal.

August brought the first crack, after trading to $1923, breaking below the 13-day moving average to $1705. The subsequent rally made a double top; a complex pattern, which has a higher reliability that a single top.  That was followed by a break below the 13-day moving average and the serious of negative Heikin Ashi bars which brought this week’s massive decline.  The fact that $1705 was broken, the previous corrective low, signals a major top is in place; one that will last very long, maybe years.

Please note, there is a confluence of Fibonacci supports and the 89-Day moving average right where Gold bounced from last Friday. This is the zone, between $1616 and $1649, that short covering will begin, and buyers who missed the big rally will want to enter on the long side. The following analysis will show why buyers here will be buying too soon.

The next chart below - I just love!  This is a weekly chart of gold which includes its “cyclical analysis”. A cycle is measured from low to low. On the bottom of the page are the weekly counts, separated by the vertical blue bars at each major low. You can see that over the past couple of years, cycles have been between 20 and 24 weeks. Each cycle low has approached the 34-week moving average, bringing a resumption of the upward primary trend. Also notice that the past three cycles rallied for the first 75% to 80% of the cycle and then had brief corrections. This cycle pattern is a “right-hand translation”, topping late in the cycle, which is another long-term bullish signal.

Now look at the present cycle. This one topped in week 9, and then went into a sharp downside correction. Because of the short-term breakdown mentioned above, it means this cyclical top is in place, in the first half of the count, This “left-hand translation” says there is another 11-13 weeks to go – of further correction. Also, the 34-week MA is down at $1560, which gold is very likely to approach before this is over. In a washout, there is a chance that the cycle support will be touched around $1470.

The last chart is weekly chart of gold, with cycles enveloped. We do this to identify direction and ranges. You’ll notice that I extended out envelops of the present weekly cycle based on the last week’s downturn. Also, I projected out the timing of the next low. I noted the ABC zigzag patterns in the brief corrections of the previous cycles. The present cycle will have longer moves, as there is more time in left for this correction. You can see, based on the angle of decline and the amount of time left, there is a potential for a lot of downside in gold over the next two to three months.

 

To review: Based on the fact that gold is now in support, it is likely that gold will move upward over the next few weeks. The rebound should bring gold into resistance between $1710 and $1740. However, the odds of any rally holding are very small based on this analysis. The following two to three months should see gold test supports at $1560, with the potential for a decline to $1470. That projects to a negative trend for gold through year end, 2011.

Full Disclosure: After being short GLD on and off the past several weeks, I actually entered a very small bullish option spread in GLD when gold was at $1642. I will be exiting and re-shorting over $1700.

Hi SLM. When I saw Hi SLM. When I saw “right-hand translation” I had to smile. Let's chat. GP Submitted by Gary Panice (not verified) on Mon, 2011/09/26 - 6:32pm » reply |