Gold Is Range Bound…and Here’s Why

03/31/2010 12:01 am EST

Focus: COMMODITIES

Gold has had some dramatic moves in the last 18 months, and we expect it will have some equally dramatic moves in the future; but not right now.

While I recognize that gold is one of the few commodity markets that people are really passionate about, the purpose of this article is not to take sides either with the gold bugs or those who reject the argument that gold is forever. Rather, I want to discuss my interpretation of the market’s cycle.

After spot gold made an all-time high against the dollar on December 2 at $1,226.37, gold has been in retreat mode. For the for the past several months, gold has been in a broad trading range, seemingly unable to move one way or another. This process has created frustration from bulls and bears alike.

Here is the dirty little secret about the gold market: It can be a horrible investment… and here's why:

Gold first started trading in the 1980’s while I was on the floor of the Chicago Mercantile Exchange (CME) in Chicago as a member of the International Monetary Market, which was at that time a division of the CME, now the CME Group. When gold opened up, the public clamored to buy into the gold futures market, and guess who sold it to them? That’s right—it was the pros—the guys who made their living trading. As a result, gold hit an all-time high of around $850 an ounce back then, and it took almost 25 years for gold to move over that level, at least in dollar terms. I don’t know what your time line is, but 25 to 30 years is an awful long time to get even again.

So what is really happening in this market?

Everyone is aware of the problems in Europe with Greece, Portugal, and a host of yet-to-be-named countries. We all know that the huge amount of money being printed, coupled with the bank failures abroad, contribute to the dollar’s declining value. These events, in conjunction with the American governments actions, also contribute to the devaluation of the dollar. The government claims that this is beneficial to exports, but the bottom line is that the purchasing power of the American dollar continues to erode in world markets.

Based on the declining value of world currency against gold, you might ask why gold isn’t trading at $2,000 or even $3,000 an ounce? What is wrong with this market? This is because a great deal of what goes into the gold market is psychological and reacts to cyclic trends driven by both psychological and economic factors.

So what does all this have to do with the price of gold now? It has everything to do with gold and nothing to do with gold.

Here is what I've been able to observe in the last several years in gold, and it seems to be holding true. It is something that you should pay attention to if you're interested in the next big move in the gold market.

Before gold can move higher, it needs to create what I call an "energy field." The most recent energy fields in gold were between May 12, 2006 and September 20, 2007. This 17-month energy field saw gold prices oscillate between a broad trading range bound by $730.08 (upside) and $541.80 (downside). That energy field produced enough power to propel gold to the new high of $1,012.40 on March 17, 2008. This marked the first time gold exceeded, in dollar terms, the highs set in the early-1980s, mentioned earlier.

The energy fields I have observed for gold are taking somewhere between 17 and 18 months to complete. If the energy field holds, then the December 3, 2009 high of $1,226.37 should remain in place for quite some time. If the same cycle remains true, then the recent lows that we witnessed, at $1,050, should also remain intact as they represent the 15- to 16-month cycle low.

With the lows in place, the next question becomes when is the next cyclical high in gold? Based on the existing cycle, we can expect the next major gold high in 2011.

To summarize: I expect gold to be locked in a broad trading range for the next 12 months, bounded by the December 2009 highs of 1,226.37 and the lows of $1,050.00. If the gold cycle holds true, we expect that gold tops the $1,226.37 marker by April or May of 2011.

On the upside, we will also be looking for gold to make a nature cyclic high in October or November of 2011. It's impossible to predict the future with any degree of accuracy; however, when we look at the cycles in gold, this reads as a pretty good bet.

No matter what happens, we expect gold will offer some great trading opportunities that investors and traders should be able to take advantage of.

As I always discuss, in trading, one should approach gold or any other market with a game plan and proper money management stops. The key to success in this decade will be investors’ willingness to move in and out of asset classes such as gold and be well diversified into more than one asset class. That way, you won’t be left holding the bag for the next 25 years. Our World Commodity Portfolio is a good example of this approach and is one I believe will serve investors well in the coming years.

By Adam Hewison, founder, Market Club

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