Gold Approaches Key Resistance

11/25/09 09:52:35 AM

by Donald W. Pendergast, Jr.

Market technicians use a variety of leading and lagging indicators to ascertain the technical state of any given stock or commodity. Right now, two reliable leading indicators are suggesting that $1,200 may prove to be a formidable resistance level for gold.

Security: Gold, GC, GLD
Position: N/A

Gold is on a rampage again and that's when the real metalheads start pounding the table, citing the falling dollar, inflationary monetary policy, and investor demand as reasons why gold must continue to march ever-higher, perhaps all the way to $2,000, $3,000, or even $5,000 per ounce. Lagging indicators are of little use in predicting where likely support/resistance and reversal points are likely to intervene, causing a pause and/or correction in gold's mighty uptrend; for example, moving averages do a great job of confirming an established trend, but they aren't as useful in helping to project the likely end of a particular market swing, as the data used to calculate the average is already past history — it's a lagging indicator, one that shows exactly what has happened but isn't of much use in helping determine what may happen in the future.

A leading indicator, by contrast, may take two distinct price inputs and then combine them in a way so as to produce a statistically plausible price projection; it may be helpful to think of eighth-grade algebra, where we take several known values in hopes of generating an accurate vale for the x factor in the equation being considered. Of course, the markets aren't as mathematically precise as an algebra equation, but it is surprising how often that leading indicators such as Fibonacci extension ratios and Keltner bands will combine to produce powerful areas of support/resistance that can also be the precursor to major trend reversals. We'll look at what I believe will be the impending collision of cash gold with the combined resistance area formed by a key Fibonacci extension ratio and the extreme upper Keltner band on the monthly chart of cash gold. See Figure 1.

FIGURE 1: GOLD, MONTHLY. Looking at this chart brings to mind the words from a 1986 rock tune: "Here it comes, there it goes; always changing hands." Might $1,200 be the point where a lot of gold changes hands?

Graphic provided by: MetaStock.

Graphic provided by: WB Keltner Channels EOD from ProfitTrader.

Fibonacci extension ratios are accurate leading indicators, frequently able to identify key zones of support/resistance long before prices ever reach the price projection. They work even better if other leading indicators such as Keltner channels are also aligned in the same general price/time zone as the Fibonacci extension ratio. When you see this powerful combination manifest in unison, it's a technical clue of major importance, one that should be taken seriously, given its outstanding track record at identifying major turns and/or consolidation points in any given market.

Currently, cash gold appears to be making a beeline for that combined price/time zone at approximately $1,196 (pink shaded area on chart), which is where swing B-C would equal 162% of the length of swing A-B and right at the point where the Keltner band is also projecting major resistance as well. If you look at the lower portion of the chart, you'll also see that the detrend oscillator has yet to exceed its previous swing high. The thing about divergences is that you never know if they're for real until the price bars on the chart confirm the divergence, but the fact that the detrend is still fairly low despite the big runup in gold prices may be another leading indicator that $1,200 is an area for gold bugs (and gold thugs — those who absolutely hate gold) to pay close attention. So, what about some possible ways to latch on to a correction near $1,200? Let's consider a few ideas.

Let's say gold has enough muscle to make it to $1,205 and then you see that it suddenly prints a key reversal on its weekly bar chart — you know, the first bar opens low and closes high, while the following bar opens high and closes low, maybe even lower than the previous weekly bar. That could be a tipoff that gold is about to reverse lower. I didn't mention this earlier, but gold is also getting close to its extreme upper Keltner channel on its weekly chart too (at a projected price of about $1,204), meaning that this key investment commodity has several powerful resistances to overcome on multiple time frames — and they all converge right near $1,200.

I'm also expecting to see the US dollar rise for no apparent fundamental reason, — this could be a great multimonth contrarian trade if you get the initial setup right. Selling far out-of-the-money puts on the US dollar index (DX) could also be a great move, should gold tumble from $1,200 in search of a new base from which to launch higher again. Of course, selling far out-of-the-money call options on April or May 2010 gold futures could also be a great trade route; it's likely that call buyers will have bumped up the implied volatility in gold calls by the time the emotionally charged $1,200 level is hit, providing for attractive premiums for sellers prepared to take on the risk of selling calls. If you do go this route, be sure to buy back any call that doubles in price, just in case gold decides to to an Energizer Bunny imitation and "just keep on going." After all, not even leading indicators are perfect; once in a while even they strike out — but not very often.

Ultimately, I'm a gold bug and not a gold thug. I firmly believe that gold will be much higher three years from now, as will most other commodities. But as mere mortals, we need to rely mostly on our charts, and especially on those leading indicators that implore us to get ready just in case gold decides to take another major breather.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

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