Gold - More Cycles, Fractals, and Updated Targets

As we wrote about last week, gold appears to have put in place a short-to-intermediate term top.  For some detailed references in this post, please make sure you understand how to read the cycle charts. 

Though last Friday wasn't THE top in the gold market, it did occur over the late session between Monday and Tuesday.  As we mentioned before, the chances of a top were good, as noted by bearish divergences and the beginning of the down cycle period.  There was a risk of a breakout when the gold price broke over the old highs, but it was negated as the price quickly came down.  We are, once again, at an interesting point.

The chart below is the updated GLD ETF cycle chart, used so we can analyze market volume quickly.  Note the circled "H" that occurred last Thursday, which was a warning of an impending top.  We noted that the top would likely be within 1-2 days of this marker, and the top did occur between Monday and Tuesday in overnight trading.  Today the price bounced off of the instantaneous trendline.  We will need to see a solid day or two below today's lows to confirm that the trending state is over, and a reasonable pullback in the gold price is underway.  That is, we must see the price fall below the instantaneous trendline until we get an "end of trend" sell signal.  Presently, we do not have this, but another day like today will satisfy this condition.

Note that the down cycle, if this is to be a short term cycle, is already roughly 1/4 of the way through.

While the head and shoulders pattern we discussed is technically out of the picture, the chance of a double top (which is essentially the same issue at hand) is present.  We're still watching the 1360ish range as a neckline that would indicate a much strong downward move in the mix.  Most of the technicals discussed last week still apply.  We encourage you to review those two posts.

This week, we add a new element into the mix--the fractal turn signal.  Below is the GLD ETF chart with a fractal indicator at the bottom instead of the cycle indicator.  We keep the cyclical supportive and resistive lines on the chart as references (remember, they act as "magnets" for the price)

The bottom section of the chart shows color-coded volume data.  Whenever a red bar shows up, the implication is that within the next 5 bars, there's a change in price direction.  So, if the trend is up and the cycle turns negative, we look for a fractal indicator (and/or a Japanese candle "end pattern") to attempt to locate tops and bottoms.  You can see a fairly recent rash of turn indicators showing up that helped forecast the recent top.

By using a combination of cycles data, fractals, and traditional technical analysis--which all use very different techniques--a higher probability of a correct diagnosis of a turn is possible.

One of the more difficult challenges with cycles work is correctly interpreting which cycle is dominant at a given time.  Here is a 3 year GLD weekly cycle chart.

Note that the only time that the price has fallen below the instantaneous trendline ("IT") was in 2008.  In fact, with the exception of that period which was the strongest pullback in gold price in percentage terms during the entire bull market, the price has simple bounced off of the IT during a correction.

The IT is currently around 1285.  The 150 dma is at 1270. The 150 wma is at 1032.  Key fibonacci retracements are at 1327, 1295, and 1263, respectively.  There is obvious support between 1250 and 1265.  The dollar is still in a weekly uptrend and daily downtrend, but not likely to rise much higher.  Thus, we believe that the best case for a gold price pullback is in the 1270 - 1285 range.  This is a change from our previous forecast of 1250, largely because the price has stayed higher than expected which have forced the trendlines to stay higher.

For the time being, silver is outperforming gold, but as the ratio is now down from 70ish to 50ish, the intermediate term outperformance is likely ending.  Our target is the 47ish level.  Note that the gold/silver ratio has not dropped below 46.74 since this bull market has begun.  Unless we're near the end of the market, gold is likely to begin to outperform.  We're taking profits on SLW, which has more than doubled in the last year.

The gold miners have broken out and are outperforming.  We expect this trend to continue as long as oil stays below $100--likely for another quarter or two.

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Einhorn Makes a Fool of a Former Fed Governor

After all of the years that we've been talking and reading about these issues, and all of the years while the masses have actually been knee-deep in the economic crisis, you'd think everyone gets it by now.  Einhorn schools a former Fed governor.

Maybe, just maybe, you'd best get a plan together for when this all goes wrong. If you plan involves a bunker, food supplies, and ammunition--you've already lost.

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On Gold - Tuesday Will Tell the Tale

Silver smashed through resistance today, and if that's any indication, we may not get that gold pullback.  Gold is right at the critical level, and unless it just stands still in the next 24 hours, either the pullback begins or the head and shoulders thesis is out.  Again, we're largely overbought again with momentum now in the territory where pullbacks have occurred with consistency.  At the same time, the divergences have begun to fade a bit.  Let's put it this way, a strong daily close above 1424.40 will attract more momentum buying and carry the price higher.  Since we're less than $2USD away, we'll likely see how this is going to play out within 24 hours.

While we are big gold bulls, the current trend makes us a bit nervous.  Either we're going to get a strong down move soon, or people are going to be bartering for food in light of the destruction of fiat currencies within the very, very near future.  Which direction it's going, we can't say yet.  One way or the other, hold on because it's about to get bumpy.

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Daily GLD Chart Update - How To Read This Chart

This post was originally penned yesterday, but given a few conflicting client meetings, we were unable to post it.  The markets are acting a bit out of turn today with stocks lower, dollar lower, and gold up.  See our post (keep in mind most of it was written yesterday) below to get a better sense of where we believe things are going.  We'll update briefly this evening with the latest to see if we're on track.

The original post:

Though the USDX was down today, gold was unable to break above 1400. As we mentioned previously, we believed that the dollar would run out of steam and turn lower, but gold would not react and would move down. To understand that position a bit better, take a look at this chart.

Again, here we use the GLD ETF chart because it's quick to analyze on a day-to-day basis.  There's a lot going on in this chart, and we hope to step you though it in a way that makes sense.  We recommend opening the chart larger in another tab in your browser for easier viewing.

Note that prices are on the left and dates are along the bottom.  The blue candlesticks are up days (traditionally clear or "white" candles) and red candles are down days for GLD, and by proxy, the spot gold price.  The upper right hand corner shows some important stats: the day's open, high, low, and close (in parentheses), the low and high values for the time period being measured (108.8208 and 139.15, respectively), the mechanical model for what market phase we're in (in this case, a bullish uptrend with an averaged trendline at 8.5 degrees above the horizontal), and finally the period of time being measured, including the number of candles (bars) on the chart.

The upper left hand corner shows what moving averages are on the chart.  First, the very important 150 day simple moving average in red, the 4 day weighted moving average in orange, and the instantaneous trendline in dark green (more about that below)

The bottom section is the Hilbert Transform sine wave. There are two lines, one red (the sine wave) and one black (the lead sine wave).  At any give time, the values of these waves oscillates between 1 (at the high end of the indicator) and -1 (at the lower end of the indicator), with the 0 line being shown as the horizontal dotted line in between.  Under the title at the top center are the values of the sine and lead sine for the day.

Before we discuss the other indicators on the chart, it's time for a little theory.  Mathematically speaking, we can define the price movement over time of any security as a combination of a cycle and a trend.  That is, the price moves up and down in a cycle that is reasonably predictable and statistically measurable.  However, sometimes prices just take off up or down for long periods in a trend.  Traders tend to look for trending movements and indicators that point to a trend likely developing.  This is because the big money is made by getting into a trend and riding it out.  Markets that "move sideways" are often very choppy.  Traders tend to lose money in these markets because it is difficult to call the tops and bottoms of moves.  The general momentum trading strategy is to get into a trend early and ride it until it fades, then find another trend and jump on board.

The Hilbert Transform is a way of determining when something is trending or cycling.  When cycling, we have found the Hilbert Transform to be very, very good at picking tops and bottoms.  When trending, it is best to use other indicators and use the Hilbert Transform as a secondary indicator.

With that said, this chart shows you how to determine what's occurring with the price of a security in terms of cycles or trends (it's something we've developed internally to show this specific format).  When trending, ride the trend.  When cycling, sell when the cycle turns.

Looking at the sine and lead sine waves at the bottom, the key is to follow the red line (sine wave).  When the sine wave peaks, a turn to the downside is likely as long as the security is in a cycling mode.  If the security is in a trending mode, then any pullback is likely to be minor and not worth selling.  The black line (lead sine) is mathematically computed as a predictor for what's about to occur with the sine wave.  As the name implies, the lead sine wave leads the sine wave just slightly, so when it turns back down and crosses the sine wave, you know that a cycle turn is imminent.  When this cross occurs, two visual indicators are placed on the chart.  The first is a red (resistive) or green (supportive) circled "H" with a white interior and a gray vertical dotted line.  This means that a cyclical turn is ABOUT to occur (in 1/16 of a cycle, or typically 1-2 days).  Note that we have such a red circled "H" with white interior today.  Once the sine has topped (or bottomed), a red (resistive) or green (supportive) horizontal dotted line is drawn at the approximate resistive or supportive level as a reference.

We should take the cycle tops and bottoms as warnings of a possible turn.  If the underlying security is behaving cyclically, many times the turn will be exact or off by 1-2 days at most (we look at fractals and other signs for confirmation).  Often, however, we will see some "overshoot" of the high (or low) point that lasts for a few days.  As long as the security is not trending, the price tends to "hang around" the red or green line.  These lines should be viewed as "price magnets."  It is common that if the price overshoots, it will not overshoot longer than 1/4 of the cycle.  If the price overshoots resistance, at 1/4 of the cycle we will get a green triangle indicator.  If the price overshoots support, at 1/4 of the cycle we will get a red diamond indicator.  These will also often mark points when we get turns during an overshoot whenever the security is cycling.

For securities like gold, which is in a very strong bull market, the security tends to trend more than cycle.  Cycling tends to occur after a major trending move when you get a strong pullback in price--then you get a period of base building, characterized by a range-bound trade of ups and downs.  That period is a cycling period.  When the price breaks up or down outside of that range, it is more-often-than-not the beginning of a trending move.  The instantaneous trendline (dark green) is a mathematically computed line that attempts to remove the cycling component from the trend.  Said another way, the instantaneous trendline shows the price trend at any given instant without the cycle tendency being included.  When a trend begins, price will often ignore the cycle tops and bottoms and start moving consistently above or below the instantaneous trendline.  The beginning of a mathematically computable trend is marked with a red (downward) or green (upward) circled "H" (note that it is a solid color, not "hollow" like the cycle indicator)and a vertical, solid blue line.  At the end of a trend, a cycle period is likely to take over.

While that's a lot of data, it is easier to see on the chart. From the 4/1/2010 date, we can see the gold price staying above the instantaneous trendline in a trending pattern (bouncing off of the instantaneous trendline frequently).  On 7/1/2010, the price fell and ended the upward trend (shown with a solid red circled "H" and a blue vertical line). On 7/9/2010, the cycle indicator showed a potential turn to the upside (which we held out for waiting for a bottom at the 150 dma).  On 8/4/2010 the gold price began to trend upward again after having bottomed for one cycle (frankly, we expected it to cycle longer than that, but...).  The price has continued to trend upward to today, with a possible warning that states tomorrow may be a short term gold top.

If you had been following this chart, you would have bought on 2/17/2010 (not shown on the above chart) at the beginning of the trend at roughly $1100 per ounce, sold on 7/1/2010 at $1200 per ounce (9% profit), bought back at $1155 per ounce and you'd still be holding today with a potential signal to sell around $1400 (21% profit or 30% profit total since February).  It's not clear whether or not the top will be reached on December 3, but the current situation presents itself as a possible top.  If so, selling near Friday's highs (at least lightening up) may be advisable.  A price drop below 1360 for a day or two implies the trending move will be over and a period of consolidation will be in order.

You can see that, in bull markets, the trend is to have short positive cycles and long trends during negative cycles.  The reverse is true for bear markets.

Note that cycles occur in all timeframes--daily, weekly, monthly, etc.  At any given time, one cycle may be the dominant cycle that must be paid attention to.  Currently, the weekly and monthly cycles are negative, but trending.  The weekly cycle has only stopped trending once in the last 10 years and that was during the credit crisis of 2008.

Note also that we also use fractals to determine the likely day (week and month as well) of the top or bottom.  When combined with other indicators, especially the Hilbert Transform, turns become much more predictable than with traditional indicators alone.  Gold currently has some signs of a possible downturn on both the daily and weekly charts.  Only a sustained move above the former highs will negate that possibility.

At this stage, we believe we're overdue for a gold pullback.  Let's see we see a top on Friday.

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Gold: From the "It Ain't A Pattern 'Til It's a Pattern, But" File

The dollar rally is extending a bit further than anticipated in the last report, though we're on target in the original forecast area for an 81-ish handle on the USDX, though there's a case to see it extend to 82-ish. We doubt that this rally has much longer, but time will tell.

The USDX chart below shows the probable targets.  It appears that we're in an A-B-C correction (a bull flag) from a larger downtrend with a target in the 150-dma-to-200-dma range at the 81.74 - 82.00 range.  This corresponds also to a 50% retracement from the June highs of 88.71 and the target of the A-B-C retracement.  RSI is approaching overbought and the stochastics are overbought.  Cyclically, the dollar should be in a down daily cycle, but more EU fears continue to make it trend higher.  We do not anticipate a break through the 200 dma to be sustained more than intraday.  If we're wrong, that means the dollar is going to enter an intermediate term uptrend.

 

The implications for gold are interesting.  Since last year, gold has been moving up whether or not the dollar has moved up.  This is because gold is now a safe haven regardless of currency it is being measured against.   Since the bull market began in 2001, gold has had only 1 major correction--the 2008 deleveraging episode.  Since then, central banks have kept liquidity high (forget austerity--that's for the peasants, not for the banks) which has allowed only modest gold corrections.  It is unclear what fundamental event could force the price of gold down in any significant way at this stage.  Perhaps another liquidity crunch that forces deleveraging (unlikely as long as any monetary regime has fiat currency and a central bank), or perhaps a sustained period where the illusion that "the major problems are solved" reigns supreme.  Regardless of the fundamental event that justifies such a dramatic sell-off, the gold picture may be presenting such a scenario.  Below, we use the GLD as a proxy so the volume information can be easily analyzed as a useful indicator:

As the title of this article states, "it ain't a pattern 'til it's a pattern, but" we're setting up for the first opportunity in some time for a meaningful reversal in gold price.  Note that we have developed a left shoulder, a head, and what appears to be a right shoulder in development.  The shoulder heights are symmetrical, but if they are to remain so, today will likely be the short term peak in price. The neck is modestly upslanted, meaning that the degree of sell-off may not be as strong as the pattern should count downward.  The volume pattern supports a developing head-and-shoulders pattern.  The initial left should peak climaxes on peak volume, sells off on lower volume, and has a minor rally at the low point.  The head is formed at higher highs on higher volume.  The right shoulder rises on lower volume.  This is a classic sign of a trend running out of steam.

In support of this position are the MACD, ADX, and MFI, which have all been in a downtrend (bearish divergence) since the top of the left shoulder formed in late October:

 

 

Short term momentum disagrees and is still rising, but this is a shorter term indicator and will turn over only after the first day sell-off begins.  RSI and stochastics are not overbought, however. 

It seems gold is at a crossroads.  If it continues to move upward with momentum, the h&s pattern will likely not form.  If, however, short term momentum weakens, then any reasonable retracement will likely activate the h&s and lead to an intermediate term sell-off.  The answer may lie in timing:

The above chart can be complex to explain.  It attempts to mathematically measure the cyclical behavior of the underlying security and provide indications on when the security will "obey" the cycles or ignore them and trend in some direction.  With gold in a bull market, clearly the bias is to trend up.  The above chart shows gold trending up against any cyclical "magnets" that should cause it to sell off.  It is currently in a short term up cycle, but that that cycle is halfway through (approximately 5 more days of "up" time) and behaving very cyclically (as opposed to trending).  Unlike most indicators, the Hilbert indicator above is predictive and not based on moving averages or other time-delayed data.  In short, we believe that there is a good chance of a turn in the next 5 days that may activate the head and shoulders and produce a significant sell-off in gold (and corresponding buying opportunity when the weak hands are shaken out).

Head-and-shoulders patterns are reversal patterns--meaning that if it becomes active (as in, the price breaks below the neckline)--we should see a downtrend occur that has some moxie.  The pattern target would take it below the short-term Fibonacci retracements toward the 1225 level as a minimum downside target.  If we see a true intermediate term sell-off ala 2008, the target price will be closer to $1000.  We know, we know--no one believes that can happen (even us).  However, that's exactly why it might.  Note that you don't hear anyone out there talking about this pattern, which usually is a sign that it may just happen.

In summary, the preponderance of the evidence suggests a correction is coming.  It may be significant.

Here's what you need to watch:

• Gold price cannot move much higher than today's high without putting the h&s pattern at risk.  If we see a higher price movement, especially higher than the previous high, the trending will continue higher and a major sell-off will have to wait
• It is possible that a sell-off will only go to the neckline and not activate the pattern (somewhere near the 1320 level). We need to see a break through this level on volume to get a bigger sell-off.  This is the first stop now for a bounce.
• If the price breaks through that level on strength, the next level to watch is between the 150 and 200 dma in the 1250 range.  A sell off that doesn't stop there will see 1225.  It is in this region that we believe is most likely to hold.
• A sell-off that breaks through 1225 may well see something around 1000 - 1050.  This is an outlier, but a possibility.  At some point during this bull market, we expect to see a sell-off that will shake the confidence of the most die-hard bulls before moving to truly unbelievable highs.

We'll know a lot more about the possible outlook within a week.

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