Is Gold’s Rally Losing Steam?

07/01/2010 12:00 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

Gold is a market that I have been writing about for many years, and it has been a great trading and investing market in this new century. Even though my monthly analysis continues to point higher, there are some subtle signs on the horizon that suggest that gold may be ready for a meaningful correction within the major uptrend.

Figure 1


Click to Enlarge

One of my favorite indicators, the monthly On-Balance Volume (OBV), has been leading prices higher since 2003. I have noted with arrows many of the new OBV highs on the chart above, as often the OBV has lead prices higher. Of course, anyone who follows gold knows there have been many sharp, and sometime quite lengthy corrections along the way. The $180+ decline from the December 2009 highs was enough to turn many analysts bearish, but the OBV indicated that this was just another correction. The monthly chart shows a rising wedge formation (lines 1 and 2) as we reach the end of June. This type of formation often leads to sharp, but often short corrections. The monthly OBV has moved above its previous high (line 4) and is confirming the new highs, so the dominant trend is still positive. Therefore, a decent correction would be a buying opportunity. And for fellow students of On-Balance Volume, gold's OBV did drop below its WMA at the end of March (point 5), but as I noted at the time, this was still consistent with a major uptrend.

Figure 2


Click to Enlarge

The weekly analysis of the gold futures reflects some loss of upside momentum, but has not yet generated any sell signals. Our upside target at $1252, which was determined by taking the 161.8% retracement of the decline from the early 2008 highs (point a) to the late-2008 lows (point b) and measuring up from these lows, has been reached. This target was mentioned in a January 29, 2009 Trading Lesson, in which I wrote:

“The close on January 23, 2009, above the 61.8% resistance level, suggests that the correction is over. Once above the 2008 highs, the first upside target is at $1130 (127.2%) with the 161.8% target at $1252. If this level is overcome, then we have the 423.8% target from the 2006 correction (point a-b) at $1332. If the April gold can surpass the $950 level, then the upside targets at $1130 and then $1252-$1332 look likely.”

The fact that we have not been able to surpass the recent highs for a few weeks is turning me more cautious, along with the fact that the weekly OBV, though still above its WMA and positive, has not yet confirmed the new highs (line 2). On the weekly chart, I have highlighted several past weekly reversal patterns (dashed lines), and such a reversal over the next few weeks could trigger a sharp decline. The weekly uptrend is in the 1150 area with the major 38.2% support level in the 1050 area. A weekly close in August gold futures below $1217 would suggest that a correction was underway.

Lesson Continues on Page 2

|pagebreak|

Figure 3


Click to Enlarge

The daily chart also gives me some concerns because while the OBV made a significant new high in May (line 2), it has failed to make convincing new highs in the past two months. A break of the daily uptrend in the OBV (line 3) would be the first sign of trouble. The volume histogram also shows a pattern of lower highs (line 4). Of course, a couple of good, strong up days—with strong volume—could turn this around. (This chart is current through June 29, 2010.)

Figure 4


Click to Enlarge

The weekly analysis of the SPDR Gold Trust (GLD) also suggests that the rally may be losing upside momentum. The very tight ranges over the past five weeks suggest there are fewer new buyers entering the market. The four-week lows so far are at $118.62. The weekly OBV is still in a solid uptrend and is well above its rising WMA. This is positive, but so far, it has not confirmed the most recent highs as it shows a potential bearish divergence. I emphasize that at this time, the divergence has not been confirmed as this data is current through June 29, 2010, and the OBV could make new highs by the end of the week. The volume histogram does also reflect low activity over the past five weeks.

Figure 5


Click to Enlarge

The divergence between some of the key gold mining stocks and the gold futures is also becoming more pronounced as these stocks do not look technically strong. Historically, the miners and the bullion often diverge, but it is also true that when the miners decline, the metals generally have trouble moving sharply higher. I have chosen two of the largest capitalization miners, Barrick Gold (ABX) and Goldcorp (GG), to use as examples.

ABX peaked in early-December 2009 at $48 and then after a correction into early February, it once again turned higher. ABX is now retesting the $48 level, but has failed to make new highs with bullion. There is a strong band of resistance in the $50-$55 area that corresponds to the $1034 high in the gold futures in 2008. The weekly uptrend for ABX is in the $37.40 area. The volume action has also been disappointing, as the OBV is still below its long-term downtrend (line 2). Goldcorp is also lagging the gold futures, as even though it briefly pushed above the December-2009 highs in early May, the stock then quickly reversed. The weekly chart shows that GG is also bumping into the former uptrend (line 3), which is not a positive sign. As Goldcorp has moved higher, the weekly OBV has been declining (line 5). Though the OBV is not always perfect, this action is not encouraging, and a break of OBV support at (line 6) would be more negative. The weekly uptrend (line 4) is now in the $39 area.

Besides the subtle signs of technical deterioration, my other concern is what I see as too high a degree of bullish sentiment. One well-known analyst, who has been skeptical of the rally since the February lows, has now changed his tune and is now looking for a parabolic move to the upside. It should be noted that my reading of the sentiment reflects mainly the view of US analysts, and clearly gold is a global market.

So what is an investor or trader to do? Investors should know that at this time, the major trend remains positive, and even a decline in gold futures back to the $1050 area or lower would not change this analysis.  If we do get a sharp correction from current levels, it should be followed by further new highs in gold over the next few years. Since the last correction was rather lengthy, this one might be brief. Those more sophisticated investors could consider hedging part of their gold position if we get a weekly downside reversal. As for traders, if we do get daily sell signals, a bearish option strategy would probably be the best approach as high call premiums might be used to your advantage. On a weekly bearish reversal with a close below $1217 in the August contract, the minimum target would be in the $1150 area. For those not long gold or precious metal stocks, I would wait for a better entry point at lower levels to get in unless we see a convincing breakout to the upside that is confirmed by the volume.

Tom Aspray, professional trader and analyst, serves as video content editor for MoneyShow.com. The views expressed here are his own.

Related Articles on STRATEGIES