Breakout or No Breakout, Short-term Correction Appears Likely

Based on the July 19th, 2011 Premium Update. Visit our archives for more gold & silver analysis.

In general, gold market overview appears mixed according to PM Investors and it is obvious. Some say gold has miles to travel, other suggest gold may take a pause before next journey and some others say it’s time for gold to fall. Debates continue in blogosphere. Recently, one of our Subscribers has sent us a link to an online article about gold being ready to drop to $1,320. This article claims there will be a decline in the price of precious metals in the second half of 2011 and that the proliferation of gold ETFs will make the drop especially violent.

The author argues that the recovery will be a long, hard slog over the coming years, rather than runaway growth and inflation or catastrophic collapse. With neither the bulls’ nor bears’ extreme scenarios proving accurate, the logic behind owning gold seems suspect. The author concludes that barring a sudden dramatic shift in economic circumstances, such as a strong oil spike or major sovereign default, we favor a drop in gold prices over the coming six months. In looking at the prevalence of investors and the ease of use of gold ETF’s, we also expect that any significant sell-off will be particularly strong and violent. We expect to see spot gold trading below $1320 by the end of the year.

Summing up, the author’s three major bearish factors for gold are that the recovery will be a long hard slog, rising interest rates and the rallying of the USD index.

We would like to share our thoughts on this topic to our readers.

We disagree that the economic situation has become stable and that there will be no extremes. We had pointed out just a few of the reasons why this is not the case in our latest gold & silver miners commentary. As to interest rates, during the previous precious metals bull market, the interest rates actually followed gold higher for considerable time before the top was reached. In a way, the fact that the rates are not rising suggests that this bull market is far from being over. As to the third argument about the USD index rallying, there have been plenty of times since 2006 when gold moved higher along with the USD Index as it was euro-weakness driven. Consequently, a rising USD does not necessarily have to be a bearish factor for precious metals at all times.

Therefore, we don’t think that gold’s fundamental situation has really deteriorated and we expect the bull market to continue.

However, in the short run, the situation might (!) be quite different. In fact, trade signals may vary according to the short-term strategies. For example, our SP Gold Bottom Indicator, flashed a buy signal on June 29^th while at the same time we were short-term bearish on the market (it turned out that we should have followed it).

Keeping this in mind, let’s have a look at current gold market moves (charts courtesy by http://stockcharts.com).

In very long-term chart for gold, we see a third attempt to move above the long-term rising trend channel. In late 2010, a similar attempt was unsuccessful and was followed by a significant decline. Certainly this could be the case this time as well. Naturally, we could see a true breakout, however so far it has not been confirmed yet, so we remain skeptical.

The current momentum, which gold has shown at the first sight seems to make the breakout theory quite probable (rallying on strong volume is bullish phenomenon), however, even gold is to rally strongly from here, a correction will likely be seen before additional significant upward movement starts. Please note that there is a strong resistance level created by extrapolating previous tops and bottoms and using the Phi #1.618. This is just above $1,600.

If gold can move above this level and confirm its move, the next target would be well above current prices. This would be quite a rally from here, but such a move does not seem very likely over the next few months – at least not yet.

In the long-term GLD ETF chart, we see a very sharp rally in the share price and this caused a similar rally in the RSI. In fact, RSI levels rose in a way which was truly unprecedented as they went directly from buy levels to sell levels. It seems never to have happened this quickly before – at least not in the past few years. Early this year and also in the middle of last year, we saw quick moves up in RSI levels but both times were a slower than this one.

Two similar sets of situations with two similar patterns each are present today. This is somewhat perplexing. Two of the similar patterns point to a decline in price to the level of the 150-day moving average. On the other hand, two additional patterns point to a small correction to be followed by a continuation of the rally. The picture should become clearer in the days ahead and other signals may also give us better insight.

Summing up, it seems most likely that a small consolidation will be seen and the way it plays out will determine where gold prices go in the weeks ahead. The long-term picture is clearly bullish, but it doesn’t mean that gold can’t decline for a month or so.

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