Gold Market Update

Some years ago I remember watching a retrospective documentary about life in Florida in the heady days of the Apollo moon program. In one bit of old film was one of those VW camper vans, of the type favored by freewheeling hippies, which had heavily darkened windows on one of which was scrawled the simple message "Don`t laugh - your daughter may be in here". I share this priceless memory with you in order to illustrate the crucial point that the way we perceive situations depends on how they affect us personally. Thus, the way you perceive the Precious Metals market at this time may largely depend on your orientation towards it, and your existing commitments in this market, if any - for as we will see, being entirely objective, there are good reasons to expect the market to go up, and good reasons to expect the market to go down, and the way you see it will depend on whether you see the glass as being half empty or half full. Does this mean that we are sat on the fence? - no it doesn`t - we are in the bullish camp at this point for reasons that will be set out shortly, but it does mean that we are aware of the bearish arguments, and would not be completely taken by surprise if the bearish case prevailed.

We have witnessed a prolonged standoff in the Precious Metals sector (and other sectors) for months now, especially in the silver market, which has been a reflection of the until recently unresolved issue of whether the powerful deflationary forces lurking in the background would gain the upper hand, as they did in 2008. A state of "trench warfare" existed with both camps slugging it out, and for weeks silver in particular looked very vulnerable to a collapse - which would have happened if the forces of deflation had not been appeased with a quick dose of "QE Light", QE standing for Quantitative Easing. This remedial action was what caused silver to break out upside from its tight Triangle some weeks back, which was an important development suggesting that both gold and silver are destined to break out to new highs and advance strongly. However, thus far neither gold nor silver have broken out to new highs and the Commercials` short positions in both metals have ramped up to historically high levels as of the last reading, so they are certainly not "out of the woods" yet.

Since on this occasion this Gold Market update is unusually magnaminous, as it caters for both bulls and bears, we will start by considering the bearish case briefly, for the benefit of those who like to see the glass as being half empty. On gold`s 3-year chart the uptrend that started in the latter months of last year with the breakout from the large V-shaped consolidation pattern appears to be running out of steam, with progressively smaller advances - the last one not (thus far) making it above the June highs, so that a potentially bearish Rising Wedge is evident on the chart, with the failing upside momentum being made clear by the lines of declining peaks on the RSI and MACD indicators. A break below $1150 would clearly be a bearish development at least for the intermediate term, as it would involve gold breaking down from its uptrend AND below its 200-day moving average, AND beneath its July lows. Such a development would project the price back to the major support shown at the top of the huge consolidation. Of course, gold could obviate the bearish case "at a stroke" as British Prime Minister Edward Heath used to like to say, by simply breaking out above the top line of the Wedge - this is what we expect to happen. British readers may also remember other politicians unforgettable trademark lines, such as Harold Macmillan's "You`ve never had it so good", Harold Wilson`s "The Pound in your pocket is still worth a Pound" - this after devaluing the currency by about 20% overnight, `s Norman Tebbit`s "On your bike"which referred to Norman`s dad pedalling around asking for work when he was unemployed back in the 30`s until he found it, or Margaret Thatcher`s TINA - "There is no alternative" which she used when she embarked on her (successful) campaign to neuter the British Trade Union movement. US readers will be familiar of course with their own home grown one liners, like George Bush senior's "Read my Lips" (no new taxes) or Bill Clinton`s "It`s the economy, stupid".

Now let's look at the bullish case for gold, using the same chart, with a technical "the glass is half full" approach. Looked at more generously, gold has actually held up well this Summer, traditionally a dull time when it retreats - although it did have a reaction it did not drop below its 200-day moving average, and by the end of Summer, the end of August, it was close to making new highs, which bulls fairly argue puts its in a good position to stage a strong advance during its seasonally strong time of year, the Fall - and we wouldn`t argue with that - it does. This is especially the case as although gold is slightly above its peak of early last December, before a heavy reaction set in, it is much, much less overbought than it was at that time, as made clear by the comparatively modest readings on its RSI and MACD indicators, and by the fairly close bunching of the price and its bullishly aligned moving averages. This means that gold has plenty of scope to stage a strong advance going forward, and barring deflation suddenly bursting into the open that is exactly what it is expected to do. Should gold succeed in busting out above the top line of the Wedge shown on the "bear" chart, a reasonable objective for the move will the top return line of the parallel channel shown on the "bull" chart, which means gold should run to the $1400 - $1500 area. If it really gets moving and goes parabolic, as could easily happen if inflation gains much more traction or hyperinflation looms, then it could even advance towards the higher parallel return line shown. How does this square with the currently high level of Large Spec long and Commercial short positions in gold (and silver) revealed by the latest COT figures - might this not stand in the way of a significant rally from here? Not necessarily - what could happen is what we have seen in the past with other commodities - both gold and silver could continue to advance in the face of these figures with the readings simply getting more and more extreme, so that the COT charts requires rescaling. We should continue to keep an eye on these COT figures as the more extreme they become, the greater the chances of a reversal.

What about the dollar - how does that look now after its recent breakout from a severe downtrend? Elliott wavers have seized upon this breakout as marking the start of a new major uptrend, and they will be right if deflation busts out and goes on the rampage again. However, if it doesn`t and is quarantined successfully, at least for a while, by QE, then the dollar`s sharp August rally will probably turn out to have been nothing more than a relief rally to neutralize the extremely oversold condition that had developed, which was magnified by panic short covering after bears had gotten over enthusiastic.

Finally, the charts of many individual Precious Metals stocks are pointing to a big rally in the sector, and while this may to a large degree be due to takeover fever breaking out across the sector, as asset hungry majors gobble up quality juniors at the current silly prices prevailing, evident from the fact that silver is the ground is now valued at a miserly 50 cents, compared to $5 in 2007, and already signalled by Kinross buying Red Back and Goldcorp buying Andean Resources for a handsome price not long ago, it is unlikely that such a rally in PM stocks will occur against the background of falling gold and silver prices. Many junior stocks appear to be powering up for major uptrends from long low bases, with strongly bullish Pan & Handle bases evident and approaching or at completion in a range of stocks.

The outlook for silver has brightened considerably in recent weeks due to its breaking out upside from the tight Triangle pattern that had developed through the Summer months, although it has yet to break out above its 2008 highs, which is a one crumb of comfort for bears, along with the latest COT figures. Many of the arguments set out in the Gold Market update are equally applicable to silver, to which readers are referred.

While it is true that silver has not confirmed gold's successive breakouts to new highs, it is also a fact that silver tends to lag gold and to do best towards the end of gold's major uplegs. Thus, if gold continues to advance it is reasonable to expect some fireworks in silver before much longer. Both metals tend to be weak and flaccid during the Summer doldrums period, and while this year was no exception, they ended the Summer, meaning the period to the end of August, looking firm, and with the seasonally most positive time of year having arrived, both look set to advance strongly soon, provided that they are not derailed by the sudden resurgence of deflation, but as set out in the Gold Market update this is now viewed as unlikely, with the QE firehoses, already used in recent weeks, standing ready to firefight outbreaks of deflation with instantly created liquidity.

For the sake of completeness, we will first consider the potential bearish scenario for silver as we did with gold, which would probably only be activated by a sudden resurgence of deflation knocking the stuffing out of commodity and stockmarkets, now considered unlikely. Up until the end of July silver looked very vulnerable on the charts, with the price retreating beneath its 50-day moving average, and both moving averages starting to swing into bearish alignment. It looked a large Double Top was completing with the highs of 2008, but then, after breaking the pattern of lower lows during the first half of August, silver suddenly broke decisively out of the Symmetrical Triangle that had been forming since May, during the last week of August. This bullish development led to a continued advance to the point where silver is now challenging its highs of 2008, however, it has become short-term overbought and so may react first before a successful breakout attempt is made. The last hope for bears is that silver fails to break out to new highs and does end up forming a Double Top with its highs of 2008 after all and therefore goes into retreat from here, which the latest COT figures, showing high Large Spec long positions and high Commercial short positions, certainly suggest is a possible outcome. Bears are therefore likely to draw comfort from a near-term reaction, which is very possible due to the short-term overbought condition and COT structure, but as we will now see this comfort may be misplaced.

The bullish case for silver at this time is easy to make. The upside breakout from its Summer Triangle has taken it away from the danger zone and resulted in its rising to its highest level for over 2 years, so that it has now absorbed nearly all of the overhanging supply around these levels - there was only a short period of trading around the early 2008 highs towards and at $21, so that the remaining overhanging is supply is light. Silver is thus now in position to break out to new highs and embark on a major upleg, especially as seasonal factors are favorable - September and October are amongst the best months for the precious Metals. Also, although silver is overbought short-term here, it is not overbought on an intermediate basis as made clear by the MACD indicator on its chart, and also by the fact that it is still not very far above its moving averages. Thus, after a possible pause or minor reaction it is likely to continue to advance to new highs, after which the rate of advance is likely to accelerate significantly.

We are bullish on silver now as with gold, but aware of the bearish arguments which are largely related to the deflation risk, which it is thought will be kept at bay by generous helpings of QE (Quantitative Easing) and competitive devaluations, hyperinflation being viewed as a better option by those in control, as it buys them more time. That is what the recent strength in the Precious Metals appears to be telegraphing.

Clive Maund, Diploma Technical Analysis
[email protected]
www.clivemaund.com

Copiapo, Chile, 14 September 2010