Monday, October 5, 2009

Gold: Off The Launching Pad

Back on April 30, 2009, when gold was trading at $895 per ounce, I wrote an article suggesting that gold was on the appropriate launching pad for a sustainable move. At that time, I did not clarify what direction that move would be. Honestly, I did not know. I did know that gold had been consolidating in a range (which I could quantify), and similar consolidations in gold usually led to a breakout in either direction.

In that article, I wrote the following:

"What we do know is this: compressed prices can lead to explosive moves in either direction.

What we don't know is this: what direction that it will ultimately be.

So this period of consolidation in gold (and most other assets) meets my criteria for a set up that can act as a launching pad for higher prices. But it can also be a launching pad for lower prices, too."

To my credit I did write the following about gold on April 30: "I wish I had an answer, but any technical indicator that I have for you would only be curve fitting in my opinion. But all is not lost as the current set up offers a low risk entry for going long gold."

See figure 1, a monthly chart of a continuous gold contract. Our indicator, which measures the degree of consolidation, is shown in the lower panel. Gold prices have been compressed to a statistically significant degree for the last 8 months. It appears that September's upside resolution or "breakout" will result in higher gold prices as volatility increases and the range is broken. Gold is officially off the launching pad!!

Figure 1. Gold/ monthly

Technically, the "breakout" as per my definition would be a close over two pivot high points, and this is what we have. I cannot be any clearer. See figure 2, a monthly chart of the SPDR Gold Trust (symbol: GLD). The pivot high point at 96.20 is now support. A monthly close below this level is reason to abandon the notion of higher gold prices.

Figure 2. GLD/ monthly

While I normally don't predict how far prices will go, we can do a price projection for GLD based upon the chart pattern. The width of the base is about 25 GLD points; we can add this to the breakout point of 96.20 and we get a price projection of 121 on the GLD.

Lastly, I will pose the following and attempt to answer in a future commentary: Why is gold breaking out? What is the significance?


RichM said...

Guy, how is that consolidation indicator (lower panel of Fig 1) calculated? Its value seems always to be 1 or 0. And it's "0, from about Nov 2005 into almost Oct 2007, even while gold rises from 575 to 725, which seems too great a rise to call it "consolidation". (Similarly, the huge drop from 1000 to about 700 through the first 11 months of 2008 also has the indicator at "0.")

Guy M. Lerner said...

Ok...I guess it is my bad on the indicator....when the indicator is 1 (or in the up position) that means there is a significant consolidation 11/05 to 10/07 --- a period when prices expanded ---there was no consolidation....the consolidation period was the 6 months prior...prices exploded higher; low volatility is followed by high volatility

One of the factors that goes into the calculation is to take a simple Bollinger Band and look for a "squeeze" ----that is when the top band and bottom band come very close together....what I do is this: I take the difference between the top band and bottom band and then wrap that value into bands with a 3 year look back period....and I set the bands to capture anytime the difference (top band minus bottom band) is at 2 standard deviations....this is just one factor....