Technically Precious with Merv For week ending 19 November 2010

It looks very much like we have reached a top in gold, but for how long?  The past week has traced out the initial potential of a head and shoulder reversal pattern (more on this below) which, if completed, would project to at least the $1230 level.  BUT the pattern IS NOT yet completed so there is still hope of more upside.  What are the odds?

Head and Shoulder (H&S) Pattern

See the chart.

Too often I see commentators talk head and shoulder (or reverse head and shoulder) while in my view the chart does not reflect that pattern.  Now, I may just be too much of a stickler for patterns but my criteria for an H&S pattern go something like this:

Consider a person standing with his hands dangling down.  Now, cut off the body at the arm pit level (forget the blood and gore).  What you have left is an arm on the left side going up, a shoulder, a head, another shoulder and then finally an arm on the right side going down.  That is a visual representation of a head and shoulder chart pattern.  MOST IMPORTANT, for an H&S pattern the lead in must be a bull market up trend.  The neckline is defined as a support line drawn from the low point of the left shoulder through the low point of the right shoulder.  Only after the breaking of this neckline AFTER the completion of the right shoulder do we have a valid H&S pattern.  Up to that point the pattern can only be described as a POTENTIAL H&S pattern.  The distance from the neckline to the top of the head is then subtracted from the level of the neckline break to give us a projection of the down move.

Many analysts (and most text books) like to see the volume action decrease at the head and decrease further at the right shoulder versus the volume peak at the left shoulder.  I find this too often in error.  A strong bull market leading to a top (head) very often has increased volume almost right up to the head just before or during the top.

I do have two additional criteria to define an H&S pattern.  First, the distance from the start of the bull trend to the top of the head must be AT LEAST two times the distance from the head to the neckline.  Secondly, the momentum indicator (I prefer the 50 day RSI) must show a negative divergence at the head location versus the left shoulder location.

This is my personal definition of a head and shoulder pattern and you can use it or not, at your discretion.  A reverse head and shoulder pattern is just upside down to the description of the H&S above, with a bear market lead-in to the left shoulder.

On this chart of the daily gold trading action all the ingredients are there for the possibility of developing a head and shoulder pattern.  We have a bull market lead-in.  We have the left shoulder, head and most of a developing right shoulder.  We have a negative divergence in the momentum indicator.  The distance from the start of the bull to the top of the head is more than twice the distance from the head to the neckline.  All we now need for this to be a confirmed head and shoulder pattern is for the price action to close below the neckline.  Because of the negative divergence in the momentum at the top I think the most likely scenario is for the H&S to be confirmed shortly.  Of course, this just may not happen and gold could surprise us and zoom to even greater heights from here so we should wait for the H&S to be confirmed before jumping the gun.  One could note that although most text books suggest the volume should be reduced at the head, this is not the case here so who knows what to expect.  I’ll go with my definition.  This is just H&S analysis, analysis of other indicators and patterns may give one a more advance signal one way or the other.

GOLD

LONG TERM

Despite the H&S analysis above the long term still does not seem in any danger of a turn around into a long term bear, maybe a short term one but not yet a long term one.  The gold price is still a long way above its positive sloping moving average line.  The long term momentum indicator (150 Day RSI) remains comfortably in its positive zone although it has moved below its trigger line and the trigger has turned downward.  This is only a very advance warning that the latest strength in the price movement has diminished somewhat but as yet not a real danger.  The volume indicator remains in a positive mode and is comfortably above its long term positive sloping trigger line.  All in all the long term rating remains BULLISH.

INTERMEDIATE TERM

On the intermediate term things are much closer to a reversal of trend.  The gold price has been trying to break below its still positive moving average line but as of the Friday close is still above the line.  Maybe the break below the line will coincide with a break below the H&S neckline.  The intermediate term momentum indicator can be seen in the H&S chart at the beginning of the commentary.  Here we see a well defined negative divergence warning of possible trend reversal.  However, the indicator itself is still in its positive zone but below its already negative sloping trigger line.  The volume indicator remains positive although much closer to breaking below its still positive trigger line.  All in all the intermediate term rating remains BULLISH but weakening fast.  The short term moving average line is closing in on the intermediate term line but at this time still remains above the intermediate term line for confirmation of the bull.

SHORT TERM

The potential H&S has already been mentioned.  Just a thought of no real significance but if you compare this short term chart with the previous H&S chart, the H&S chart looks much more aggressive.  The “slope” of the bull trend is more vertical.  I mention this because we often hear about aggressive trends, whether we call them blow-off trends or strong bull or bear trends, and that they cannot last long because of the steep slope.  Well, all one has to do is change the vertical or horizontal scale and voila, you have a much diminished slope or trend.  A sharp slope can be made out of almost any trend by compressing the time period or expanding the vertical scale.  The action is not changed but the slope of the action has.  So just be cautious whenever you hear anyone mention aggressive trends.  I know, I often mention them so be aware.  But I digress, again.

Although the other time periods are still bullish that is not for the short term trend.  The gold price has been trading all week below its short term moving average line and the line slope has decidedly turned to the down side.  We seem to have a bounce off the intermediate term moving average line but that bounce seems not to have much strength in it.  The short term momentum indicator dropped into its negative zone this past week and remains below its negative trigger line.  The daily volume action remains somewhat muted but this is to be expected.  All in all, the short term rating is BEARISH.  The very short term moving average line has now moved below the short term line for confirmation of this bear.

As for the immediate direction of least resistance, one might think that would be to the up side given the bounce we have had these past few days but I’m not sure that bounce will last much longer.  On the other hand the aggressive Stochastic Oscillator (SO), which was in its oversold zone, has now moved above its oversold line and above its trigger line for a signal that some strengthening may be in order.  I’d give it another day to confirm that strength and go with the lateral direction for the next day or so.

SILVER

This commentary is primarily about gold.  Silver seems to get short shifted in the commentaries even though there are times, such as these, when silver is actually the far better speculation.  I include a silver commentary section because my various precious metal Indices include gold and silver.

As previously mentioned in these weekly commentaries silver has been out performing gold lately.  The short term chart of silver shows a similarity in chart pattern with gold except that the silver chart shows a stronger recent trend.  The H&S pattern here is much more upward sloping to the point I would not consider it a potential H&S but more accurately a higher high, higher low pattern.  The intermediate term momentum indicator has not shown a negative divergence although it has shown some weakening in the strength this past week.  One interesting feature of the silver chart is the slight expanding wedge pattern shown.  These expanding wedge patterns too often have as their end result a break to the down side so one should be on guard.  Should gold go into a bear move, whether short or intermediate term, then silver is highly likely to follow regardless of its present strength versus gold.  

The ratings for silver remain BULLISH for all three time periods.

PRECIOUS METAL STOCKS

The silver stocks continue to move higher as the gold stocks seem to be getting ready for a reaction.  The universe of gold and silver stocks had a basically neutral week (except for those silver stocks) while the major North American Indices were on the down side.  The Merv’s Indices are starting to show some weakening momentum and most of my momentum indicators are in their overbought zones so a reaction from about here would not be a surprise.  I’ll leave the stock commentary for another day.  One can gain most information about the stock trends from the Table below.

Merv’s Precious Metals Indices Table

Well, that’s it for this week.  Comments are always welcome and should be addressed to [email protected].

Merv Burak, CMT

Hudson Aero/Systems Inc.

  Technical Information Group

                   for

Merv’s Precious Metals Central

21 November 2010

For DAILY Uranium stock commentary and WEEKLY Uranium market update check out my new Technically Uranium with Merv blog at techuranium.blogspot.com.

During the day Merv practices his engineering profession as a Consulting Aerospace Engineer.  Once the sun goes down and night descends upon the earth Merv dons his other hat as a Chartered Market Technician (CMT) and tries to decipher what’s going on in the securities markets.  As an underground surveyor in the gold mines of Canada’s Northwest Territories in his youth, Merv has a soft spot for the gold industry and has developed several Gold Indices reflecting different aspects of the industry.  As a basically lazy individual Merv’s driving focus is to KEEP IT SIMPLE.

To find out more about Merv’s various Gold Indices and component stocks, please visit preciousmetalscentral.com.  There you will find samples of the Indices and their component stocks plus other publications of interest to gold investors. 

Before you invest, Always check your market timing with a

Qualified Professional Market Technician