Is Gold’s Correction Almost Over?

01/25/2010 11:07 am EST

Focus: COMMODITIES

Thomas Aspray

, Professional Trader & Analyst

In our last article on gold, released on December 28, 2009, I discussed the technical signs that suggested gold’s correction was over. At the time I concluded “Though the recent lows could still be tested or slightly broken over the short term, the recent action indicates a tradable low is now being formed.” February gold closed on December 28 at $1107 and declined to a low of $1086 two days later before turning higher. The rebound has taken April gold up to a high of $1163, falling just short of the 61.8% retracement resistance at $1169. The heavy selling during the week of January 18 has taken gold back toward the recent lows, so what’s next?

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Figure 1 - Click to Enlarge

Before I attempt to answer that question, I think it might be informative, especially for those who are new to the gold market, to examine the recent decline in terms of past market history. On the weekly chart above, I have identified six different corrective patterns that go back to 2003 and were all viewed in the context of gold’s uptrend from the 1998 lows. These look minor on the weekly chart given gold’s dramatic rise, but even the drop from the February 2003 highs to the April lows was an 18% decline. In 2004, there was a 14% correction, and in late-November 2004 through early 2005, there was a 10% drop. In 2006, the correction in gold took the form of a triangle formation and amounted to a 25% drop from high to low. The 34% correction that occurred in 2008 was severe and lasted long enough (seven months) to convince many that long-term trend in gold had changed. There was also a 14% correction in 2009 as gold had come close to the 2008 highs before it turned lower. This correction retraced just over 38.2% of the rally from the late-2008 lows. From this analysis, it should be evident that gold’s current 12% decline from the December 2009 highs is not that unusual. The average of the prior six corrections has been 19%, which, when calculated from the 2009 highs, would take gold just below $1000.

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Figure 2 - Click to Enlarge

Obviously, I feel there are better and more accurate ways to determine where a correction is likely to end than by looking at average corrections. Of course, one needs to have strong opinion about the major trend in order to calculate possible correction targets. The weekly OBV (Fig.1) made strong new highs with prices at the recent highs, and the weekly/monthly OBV have been leading prices higher for some time. Before a major top is complete, I would expect to see some significant divergences on the weekly technical studies. The OBV is just coming back into a major support zone where I would expect it to bottom out. (Editor’s Note: The scaling of the OBV has been modified in order to see more detail of the recent period.)

Looking at the April 2010 gold contract, we can see that the first decline from the December 3 highs (point a) held above the 50% support level ($1069) from the July lows (point b). The more important 61.8% retracement support is at $1032, which coincides nicely with the major 38.2% retracement support level from the November 2008 low, which is at $1033. There are also some interesting projection targets that can be derived from the decline from point a to point b. If the decline from point c were to equal 61.8% of the decline from points a to b, then the target would be at $1073, very close to the 50% support at $1069. If the decline from point c is equal to 100% of the decline from points a to b, then the Fibonacci projection target is at $1015. This corresponds closely to the 161.8% corrective extension of the point b to point c rally, while the 127.2% extension target is at $1052.

The most likely scenario, in my opinion, is for the decline to terminate in the converging support zone in the $1032-33 area. The second is for gold to test or slightly exceed the late-December lows (possibly $1052) before turning higher. At this point, the least likely scenario is a decline in gold to the major 50% support level at $973. To indicate that the correction is indeed over, we need to see a shift in momentum or a candle formation that is consistent with a turning point. This was the case in late December as the RSI3 formed a double bottom in late December, followed by a bullish pattern (see rectangle). The RSI3 turned lower on January 12 and is still declining sharply. It would take several days for it to bottom out. I still feel, as I did in December, that it will take some time before gold is ready to challenge its recent highs. For a further discussion on gold, gold ETFs, and the other metals, sign up to receive this week’s Trading Lessons e-letter, which will be released on Thursday.

By Tom Aspray, Trading Lessons editor, MoneyShow.com

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