MONDAY, JULY 19, 2010
Don't Buy the Gold Correction Just Yet
By MICHAEL KAHN
While the yellow metal's price has fallen since June, the charts suggest that the price could fall even further before recovering.
THE BULL MARKET FOR GOLD is finally taking a breather. After setting a fresh all-time high in June at $1266 per ounce, the yellow metal has fallen more than $80.
But unlike previous pullbacks, this time it has broken a few technical supports. In other words, it does look like a serious correction has set in.
While the short-term looks weak, the long-term bull market is far from endangered, even though it fell a bit short of the initial upside target of $1350 I laid out in a previous column (see Getting Technical, "Gold's Next Leg Up is $1350 an Ounce", December 9, 2009). When the current down draft shows signs of ending, investors should find a good opportunity to get back in for the long haul to 1350 and possibly beyond.
Gold broke sharply July 1, falling $40 on rather beefy volume. It was the first shot across the bow for speculators as it did indeed break the short-term trend to the downside (see Chart 1). After licking its wounds for a few days, the second shot was fired July 16 as gold shed another $30.
Chart 1
Chart watchers will note the period between these two steep declines left a "bear flag" in place. This pattern is merely a countertrend rally on low volume. For a rising market correcting lower, it looks like a flag flying on a flag pole. For a falling market, the pattern is inverted. For gold, it suggests lower prices are coming.
How low? One school of thought says that the downside target is derived from the height of the flag pole. In this case, we measure from the peak at 1266 to the start of the flag at 1185. Project that height - 81 - down from the top of the flag at 1219 to get an initial target of 1138.
There is ample chart support in that area from various turning points between December and April so this target makes sense. In addition, the 200-day moving average is in the area making it a compelling price objective. In other words, bulls should probably wait to at least this level before jumping back in.
But before making this call we have to see how it fits with the bigger picture. When we pull out to the long-term, we will see the bull market beginning in 2001 with a well-tested rising trendline from the 2008 low (see Chart 2). If gold does indeed fall to my first target of 1138 it will break that line to the downside.
Chart 2
Therefore, we must consider the next major support in the 1050 area from the bottom of the December - February decline. It is more than just coincidence that this is the second integral multiple of the downside objective measured by the bear flag. Subtract the flag pole height - 81 - from the first target - 1138 - and get the next target of 1057. That is close enough for our purposes today.
If the market makes it as low as 1057 it would be a good place to consider getting back into gold.
Gold stocks are a different issue. While gold scored record highs this year, the Market Vectors Gold Miners ETF (GDX) could not follow suit (see Chart 3). In fact, it was turned back in the 54-57 zone where rallies stalled in each year from 2007 to the present. It is quite a formidable resistance ceiling.
Chart 3
The chart shows the ETF now breaking down below its rising 2008 trendline. However, unlike gold itself, the ETF has also moved under its 200-day moving average. Adding to the bearish case for gold stocks, the relative performance of the ETF to the Standard & Poor's 500 took a sharp turn for the worse last month.
The bottom line is that gold looks to be in a significant correction now and gold stocks are in somewhat worse shape. If and when the metal reaches its downside objective, I will look for a resumption of its long-term bullish trend.
Gold stocks do not offer that promise so we'll have to see how they look at that time.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
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