Gold Break. Sea Change?

The behaviour of the gold price over the past 48 hours is reflected in the chart below - source http://quotes.ino.com/chart/?s=FOREX_XAUUSDO

At close of play on February 19th 2007, the gold price had been trading at around $670/ounce for a day or so. Given the technical indicators on the daily chart below (courtesy Decisionpoint.com), it might arguably have been approaching a technically overbought situation.

These technical indicators were:

• Price approaching the resistance of the upper trendline
• Distance of price away from its 200 day Moving Average was getting larger
• $665 - $670 level represented resistance which manifested in July 2006.
• The PMO oscillator was reaching resistance at the 2.0 level (a bit iffy, but arguable)

As at yesterday morning (February 20th 2007) , in terms of the vertical count target destination on the Point & Figure chart below, had the gold price broken up above the $675 level, it would have yielded an upside potential which was significantly higher than the previous five year high. In turn, such a breakout might have sent a warning message to the global financial markets, which message might have been very destabilising in terms of underlying confidence. Therefore, from the perspective of those in whose interests it might have been to prevent such a breakout, it was time to act.

But something may have changed. In this analyst's view, that something may not have been a trivial change, it may have been the beginning of a sea change.

This is how I see the 'possibilities'. (Clearly I am guessing here, because there is, as yet, insufficient proof to validate my conclusion):

In summary, if you were a Central Bank charged with the responsibility of managing the gold price, the morning of February 20th 2007 might have looked like a sensible time - given the risks of a breakout, and the arguably overbought situation - to sell gold short. Also, from the Central Banks' perspective, they could rely on a cadre of Commercials who, the Central Banks would have known, have been in the habit of riding on their coat tails. It would therefore have seemed a relatively safe bet to assume that the computer programs of the Commercial traders would pick up on the Central Bank selling pressure and start to flag their own sell signals.(Note: It might not have been a Central Bank operating for its own account. There may have been a trade instigated on its behalf by a Commercial operator)

That's probably what happened on February 20th 2007.

Moving on …….

Bright and early on February 21st, the self satisfied traders who had seen a $15 paper profit unfolding the day before, probably decided that they would crystallize this profit by covering their shorts. Maybe their computer programs were even flagging that they should do so. My guess is that the computer programmers probably hadn't factored into the equation the fact that there are now some well cashed up Gold ET Funds which represent "strong hands", who were happy to receive the $15 gift, and who happily bought whatever the short sellers were dumping.

Today, on February 21st 2007, when the Commercials came in to cover their shorts, they had a rude awakening. There was no gold to be had. The price jumped from $656.50 to $682.30 and, in the process, forced the breakout on the Point and Figure chart.

In this analyst's experience, the 3% X 3 box reversal Point and Figure Chart has been the most reliable because it ignores trading 'noise', and it is reproduced below.

Following the breakout from the triangle - yet to be confirmed by an upside break beyond $691.24 - the more conservative horizontal count technique is calling for a target destination somewhere in the region of $755 to $760 (a new high), whilst the vertical count target is now over $1,400 an ounce.

As I watched the above scenario unfolding, it reminded me of a lunch conversation I had with a team of bond traders some time 1986. I had been writing a bi-weekly technical assessment of bond yield movements on behalf of one of the leading stockbrokers in South Africa. At that time such an approach was revolutionary. Black-Scholes was the only way they knew to value bonds then, and this particular institution had asked the broker to set up a lunch. They had been reading my technical assessments, which were based partly on Daan Joubert's computer algorithms and partly on 'flair', and they had decided it was time to write their own computer model. They wanted to pick my brains.

I will never forget the expression on their faces when I told them that, in my view, what they were planning was extremely high risk. Their facial expressions reflected several emotions, most of which are not relevant to discuss here. As politely as they could muster, they professed to be shocked at my response, and wanted me to explain why.

Here is a summary of my answer at that time.

"I believe that trying to mechanise a trading approach to the markets will one day - and with the benefit of hindsight - be seen to have been a mug's game.

The markets operate on three levels:

1. Long Term "Philosophical" level
2. Medium Term "Strategic" level
3. Short Term "Tactical" level

What you guys are planning to do is focus on the short term tactical level and get the computer to automatically generate technical buy and sell signals based on sophisticated statistical algorithms.

In my view, you will make a killing when the Strategic and Tactical directions of the market are aligned; you will battle to make profits when the strategic and tactical directions are not aligned, and you may be wiped out when the day arrives that the market turns for philosophical reasons. No computer program will ever be written that will pick that turning point".

(As an aside, the 1987 crash was a foretaste of things to come. That was a "tame" example of what I believe will - one day - happen even though there are speed bumps now built in. The 1987 crash was quickly brought under control, and the speed bumps were put in place. I would recommend that serious students of the markets should go back and study those few days in 1987. When the market decides to panic, we will have several consecutive "limit down" days, but we are not there yet. We may be anything up to five years away from that point, but it could well happen sooner. The longer it takes to manifest, the more vicious it will be. The break-up of the Dow Jones Industrials was not a harbinger of good economic times ahead).

Getting back to the story, the broker paid for lunch. The attitude of my lunch co-guests - given that they were in high power careers that were bonus driven, and that they were working with 'Other People's Money' was understandable, if not admirable.

"In the longer term" they said "we will have moved on and it will be someone else's problem".

Since then, traders world-wide have made squillions for their employers, and millions for themselves. Increasingly sophisticated trading systems have emerged which are more and more sensitive to trading eddies. Mathematicians now dominate the financial trading activities. They are the rocket scientists.

Since those days, I have concluded that the markets also operate at a fourth level, a 'human evolutionary' level. Right now, I believe I may be all alone in this view. Most people today will regard such a view as 'flaky'. Some will acknowledge the possibility, but will argue as Keynes argued that, "in the long term, we are all dead". They will fail to understand that, at the end of the last short term cycle within the long term cycle, that event will signal the culmination of the long term cycle. At some point, the short term and the long term coincide.

The problem, as I see it, is that rocket scientists tend to know squat about the power of the human psyche, and are even less interested in the grand sweep of history. When I talk about the 'grand sweep', I am thinking b>thousands of years; the level at which evolutionary changes take place. The rocket scientists will never be able to write a program that will recognise a 'philosophical' or sea change when it hits, let alone an evolutionary change - which is what I personally believe we are now witnessing.

By way of one small, but important example, the conclusions of Al Gore's 'An Inconvenient Truth' are based on a computer model which was reportedly erroneously structured to start with, and which very probably does not factor in this grand sweep that I am talking about. I believe he may be making an extraordinarily serious mistake. But I am an optimist by nature. I also believe this mistake is probably addressable. It's just that addressing it will represent a bigger challenge than if he had not arrived at his mistaken conclusion and 'sold' it to the world.

It's early days yet, but my gut is telling me that February 21st 2007 may turn out to be the date that the sea change started to manifest. Right now I am in the minority, if not alone in my views. However, if and when the Gold Price rises to new all-time highs, and just keeps on going, people will increasingly begin to recognise this possibility.

At that point, I will probably announce the imminent release of a novel I have been writing over the past eighteen months, which explains why we are approaching the end of a frenetic evolutionary era, and what - precisely - we might do to ensure the ushering in of a new and more tranquil era. The announcement article has already been written. It will be submitted for publication when the gold price can be seen to be rising to new highs. Given that the Central Banks will be fighting to protect the integrity of the entire system, it might take anything from a week to a year for those new highs to start manifesting.

The chart below - courtesy Decisionpoint.com - puts this anticipated breakout into perspective. Note the position of the PMO oscillator. When sea changes occur, these oscillators tend to give false signals and the oscillators can remain overbought or oversold.

That today's move in gold may turn out to be significant, can be seen from the daily chart of Newmont (courtesy bigcharts.com). Note how its price is now peeking tentatively above the 200 day moving average

…. although it has not yet broken up above its 40 week Moving Average on the longer term weekly chart below

Having said this, the ten year monthly chart - relative to the $XAU - shows that NEM is trading above its 48 month moving average. The anomaly probably flows from period end differences.

On balance, it looks like an upside break in the gold price is a matter of time. Note how the oscillator on the weekly gold chart is giving a "buy" signal and how the price is now bumping up against the resistance of a steeply rising trendline. My guess is that if/when the gold price rises to new highs, that trendline will be penetrated on the upside and - like the Dow Jones Industrials - Gold may also enter an exponential blow-off phase. We will need someone to plot the gold price on semi log scale - which it appears is not the case with these two DecisionPoint charts. A Pity about that, but it'll all come out in the wash.