Your assignment, should you choose to accept it, is to study this chart and tell me where you think the white line is headed next. The white line shows the movement of the price of 1 ounce of gold from October 22, 2000 through today. Based on what you see, would you think that the next major move will be upward or downward? Welcome to my world. This is what I do every day.
Before you sweat over it for too long, let me tell you that this chart paints a picture of a commodity that is looking more and more like it has topped out, and the path of least resistance is downward. The price of gold could decline all the way back to about $470 per ounce and gold would still be in the long term rising trend that dates back to the summer of 2001. You can see that by focusing on the red line that is rising from left to right and turns into a blue line. The rising blue line intersects the right side of the graph at about $470 per ounce. Even at that level gold remains in its long term bull market. So one might ask, “Paul, are you predicting that gold will drop to $470?” For right now the answer would have to be no, but I am keenly aware that it could happen. But before it does gold has to work its way down through several layers of “support” below the current price.
This chart shows the price of “spot” or “cash” gold. It is not a “futures” chart. Today “cash” gold broke below its 50-day simple moving average (50 SMA). This is the third time it has done that since the peak. It is a sign that gold prices are weakening. FYI, the 50 SMA does not appear on the chart. The next level of “support”, as gold works its way downward, is the 200-day SMA (200 SMA). It lies just below at $576.50. That line is not on the chart either, but if gold breaks below that level it has to be considered a serious breakdown from the point of view of either a trader or an investor.
A break below $576.50 increases the odds of a decline to $548.41, which is the top blue line on the chart. The three blue lines represent the key levels for “Fibonacci retrenchment patterns.” What the heck is that you might ask? Here is a textbook definition, “A term used in technical analysis that refers to the likelihood that a financial asset's price will retrace a large portion of an original move and find support or resistance at the key Fibonacci levels before it continues in the original direction.
Believe it or not, Fibonacci was a mathematician who devised the formulas and relationships that make up Fibonacci retrenchment patterns in the year 1202. But that is quite enough technical analysis jargon and certainly quite enough of a history lesson.
Let me cut to the chase and tell you that the odds now seem to favor a continuing decline in the price of gold, at least back to the $548 level. I could write two to five more pages explaining why, but I am going to save me the time of writing and you the time of reading. The best explanation that I can give you is one that has been offered before, i.e., too much speculative money came into the gold market and pushed prices upward too far and too fast. That “speculative” or “fast” money seems to be working its way out of positions in gold now.Other reasons include the fact that central banks around the world are diligently working to slow economies down. They are raising interest rates and they are draining currency liquidity. “Money supply” growth rates seem to be much more constrained around the globe than we thought they would be during 2006—at least for now. If you want to review our take on this issue you can review in our Annual Report to Clients, Parts 1&2 which are on the website at http://www.kaassets.com/illuminations.htm.
The bottom line is that we think that gold remains in a long term secular bull market that started in 2001. We are still bullish on gold for very fundamental reasons and think that it is highly likely that prices will eventually exceed the old highs established in the early 1980’s. But that upward trend may resume from levels that are significantly lower than current prices. We may have to get through a significant drop in prices first, before resuming the upward trend.
It is too early to tell exactly what is going to happen with gold in the short term. The markets can’t be forced. We wrote all this about gold in order to inform you that conditions may be changing.
Gold is not the only commodity that is going through some retrenchment in price. Here is a short term chart of the CRB commodities index; courtesy of Richard Russell. It is going through a similar retrenchment pattern. It reflects that price action in a broad cross section of commodities.
Now check out the chart for light crude oil. This chart is from a different source and is a different type of chart. But the first thing you should notice when you look at it is that the long term rising trend has not yet been interrupted. You are looking at a rising trend from about $28 per barrel in October 2004 to $71.81 per barrel at the close tonight.
The smooth rising red line is the 200 day simple moving average (200 SMA). It is clearly rising and at a steady pace. There is no “spike” upward to interrupt the trend like we have experienced in gold. By comparison this has been an orderly move upward and that has not yet been interrupted.
Forced to predict the future direction of this chart line, we would have to say that the trend is intact until it is interrupted. In other words the trend remains upward. Oil could drop back to $67.08 per barrel (the 200 SMA) and the upward trend remains intact.
Take a look at the RSI (relative strength) indicator, which is the black squiggly line that runs across the top of this chart. Notice that it fluctuates fluctuates between a high RSI of about 70 (see that?) and a low RSI of about 30. (Those numbers are on the upper right side of the page.)It (RSI) bounces up and down. It is approaching 30 again and we interpret that to mean that oil is again approaching a point at which it becomes “oversold”. Notice that when the RSI approaches the 30 level that the price tends to bottom out, and then moves back upward as RSI increases again. What can we say other than this is a trend that remains intact? If the trend starts breaking down, like it seems to be doing in gold, we will alert you. Until it does one has to assume that higher prices are likely.
We know of several technical and fundamental analysts who think that oil’s run is over too. We recently wrote a newsletter that we called “Oil and Gas Got Shmooshed!” that discussed the fact that many oil related stocks have started to retreat from their highs in anticipation that oil prices will be dropping. That newsletter is available at http://www.kaassets.com/illuminations.htm. But if you look at a simple chart of oil price trends there is no evidence yet of a downtrend.
What gives with this crazy stock market? Frankly one graph of one portion of the stock market doesn’t do justice to what we would like to discuss. But we are going to make it work. Here is a current picture of the S&P 500 as of the close tonight. It is a picture of a nice rising channel. At first glance it probably looks pretty similar to the chart of oil, but it isn’t.
Check out the lateral blue line that I have placed across the top of this rising channel. It marks the recent top of the market in May. We are approaching it again. Now check out that RSI indicator across the top. Notice that we are closing in on 70 again.
That has normally marked the top of upward thrusts in this stock average. Could it be that this latest rally will expend all its remaining energy simply getting back to the recent high? Only time will tell, but if we had to “guestimate” that would be our “most likely case”.
The big difference between the chart of oil and the chart of the S&P is that oil is at a low point in RSI (near 30) and poised to start working its way back upward. The S&P 500 RSI is nearing the overbought condition of 70 and more likely to turn down, than up.
And then there are bonds; what are the charts telling us? This is a picture of the price movement of the 30 year U.S. Treasury bond. Notice that price bottomed out in the May through July period. See the blue line at the bottom. Now prices of bonds are increasing. See the rising blue line to the right. This chart is courtesy of Richard Russell.
As prices of bonds rise, yields fall, and that is exactly what is happening. The Fed may be raising short term rates, but all other longer term rates are already declining. That is consistent with a slowing economy, and so are the rest of these charts, with the exception of the chart of oil. At some point, as the economy slows down, oil prices should slow down too; reflecting slowing demand for the commodity. There is only one problem with that theory. What if demand continues to grow faster than supply?
If that is the case then the economy is potentially in more trouble than the Fed thinks. It may be one reason why you could see them change course and start lowering rates and adding liquidity sooner than later.
So there you have it; four different markets in potentially four different conditions. Gold looks like its path of least resistance is downward. Oil’s upward trend appears to be intact. The stock market, or at least the S&P 500, looks like it might be about to top out, at least for the moment. Bond prices are rising and yields are falling. Well, at least that is how I see these charts. What about you?
Got any questions about why we have reduced allocations to gold and other commodities in the past few months; we have held pretty steady in oil; we are nervous about stocks and our trading activity has increased to keep ahead of the game; and we added a substantial allocation to agency bonds (in June)—in the four model portfolios called Hatteras, Mendocino, Bonavista, and Halifax.
Welcome to my world. It is Friday night and I am studying charts. Imagine where we might be had the terrorists in London been successful last week. But that is a subject for another night. Have a good weekend.
By the way, I heard a rumor that I give the impression around the bank that I don’t work hard. Guess I make it look easy. Maybe that isn’t all bad. Go figure.
All the best, PK
Paul Krsek
For K&A Asset Management, LLC