Gold Market Update - August 7th, 2011

What happens to gold if the markets crash? This is the question that many would like an answer to, as it is looking rather likely after the announcement, conveniently made after the markets closed on Friday, that Standard and Poor were lowering their rating for US debt.

Actually the markets started to crash on Thursday, with major indices breaking down from a large Head-and-Shoulders top, as we can see on our 1-year chart for the S&P500 index chart below. By Friday’s close the markets had become deeply oversold, and while this could lead to a technical rebound towards the neckline, it would very likely be followed by renewed decline, but because the breakdown was such a seriously negative technical development there may be no rebound at all – instead the markets could accelerate away to the downside. Banking and financial stocks in particular look truly awful with major support levels having just been breached and little but air beneath most of them.

To answer the question regarding the outlook for gold we will start by looking at the longer-term 6-year chart. On this chart we can see that gold is certainly not a bubble commodity as some like to claim. Instead it has been plodding steadily higher in response to the concerted worldwide attack on the value of fiat by politicians, which shows no signs of ending. The 2008 crash pushed gold lower sufficient to turn its 200-day moving average down, but notice that it did not result in gold breaching the zone of support at the top of the 2006 – 2007 consolidation pattern and gold certainly held up better than most asset classes. Could a general market crash result in it breaking down from its current orderly uptrend and entering a period of more severe decline as in 2008? Well, it could, and if it should break down from the channel it would constitute a trading sell signal, but remember, things are different this time round, as especially after the ratings downgrade on Friday, investors might be less keen to flee into Treasuries and the US dollar, although we should be careful not to underestimate their capacity for stupidity – it doesn’t seem to cross the minds of most of them that they would be far better off in bear ETFs. Long-term the outlook for gold remains super bullish, especially as it is still a long way from being a bubble.

The shorter-term 4-month chart for gold certainly does give grounds for caution, especially for shorter-term traders. For on this chart we can see that it is definitely looking overbought after its strong run of the past 5 weeks or so that has taken it to new highs, and attracted the attention of the mainstream media (it’s only taken them 10 years to start to cotton on to gold as an investment, better late than never I suppose). Gold has been running a critically overbought condition on its RSI indicator for a couple of weeks now and is very overbought on its MACD indicator, in addition to which it has opened up a significant gap with its moving averages, although it can get larger as we can see on the 6-year chart. The big move up last Tuesday looks like a blowoff move and it was followed by short-term bearish looking candlesticks. All of this suggests that a reaction is likely soon that could carry gold back to the channel support line shown on the 6-year chart, and possibly lower.

The contention that a reaction back soon by gold is likely is certainly supported by the latest COT chart which looks bearish for the near-term. On this chart we can see that the Large Specs have gotten themselves worked up again, and are foaming at the mouth, which usually happens at or near a top. Meanwhile the Commercials are running large short positions again.

Many PM stock investors are of course wondering if a market crash will drag down PM stocks. We got the answer to this question on Thursday when the HUI index plunged along with the broad market, although it has not yet broken down below the support at the bottom of the menacing potential Head-and-Shoulders top that we can see on the 3-year chart for this index shown below. If this support fails it will open the door to a brutal selloff as in 2008, so if it does fail it will be viewed as a general sell signal and investors in the sector will want to stand aside if this happens.