A Tale of Two Charts: A Bullish and Bearish Case for Gold

By Clive Maund of CliveMaund.com

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, the type favored by freewheeling hippies, which had heavily darkened windows, and on one of them 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 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.

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Since on this occasion, this gold market update is unusually magnanimous, as it caters for both bulls and bears, we will start by briefly considering the bearish case for the benefit of those who like to see the glass as being half empty. On gold's three-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.

NEXT: The Bullish Case for Gold

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Now let's look at the bullish case for gold, using the same chart, with a technical "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, or end of August, it was close to making new highs, which bulls fairly argue puts it 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 be 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 speculative long and commercial short positions in gold (and silver) revealed by the latest Commitment of Traders (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 require rescaling. We should continue to keep an eye on these COT figures because the more extreme they become, the greater the chances of a reversal.