Gold's Monthly Chart Warns Of More Downside

11/19/10 12:04:15 PM

by Donald W. Pendergast, Jr.

Gold ran up from $681 to more than $1,423 in a little more than two years; after hitting previously forecast resistance levels, the gold futures market is beginning to turn lower. Where are the critical long-term support areas that traders and investors need to be aware of?

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

It's been a fairly smooth ride for gold bulls since the washout lows seen in late October 2008, with the metal up by more than 108% in two years. With gold futures having fallen by as much as $100 an ounce since November 9, 2010, the big question now is just how far this correction will go. We may see a reaction rally higher, and that wouldn't surprise gold analysts at all, but if we take a long hard look at a monthly continuous futures contract for gold, we see that the odds favor more downside so that several important support levels can be tested before a new bullish up leg can commence.

FIGURE 1: GOLD, MONTHLY. If you see November's price bar close below the October low at 1309.00 (which would be a key reversal), prepare to see some more downside in this highly emotional market. Fibonacci support at 1251.00 is the first likely target, should that actually happen.

Graphic provided by: MetaStock.

Figure 1 features three dissimilar technical analysis techniques, two of which are especially useful during pullbacks during major up- or downtrends, and a pair of volume indicators that you don't normally see a lot of analysis on -- a pair of incredibly useful indicators that can help confirm the existence of strong trending phases and also help warn of impending divergence/corrective phases in a given market.

Let's start with the support indicators, one of which is also a wonderful trend confirmation tool -- the 12-month simple moving average (SMA). On this monthly chart for gold, note how well the 12-period SMA (red line) helps delineate the uptrending phase. When the monthly price closes above the 12-period SMA and the SMA is rising, the market is in a powerful uptrend. The same holds true for downtrending phases in a market as well. Some institutional traders ascribe a great deal of weight to the 12-month SMA configuration to the stock, forex, and commodities markets, which may help explain why you see such powerful moves (in either direction) whenever a stock or futures contract manages a monthly close above or below this key moving average.

Right now, the 12-month SMA for gold futures is at 1206.61 and rising, so, according to this interpretation, gold is still in a bull market. However, given the sharp turn south in the gold market over the past two weeks (warned about well in advance by the positive volume and negative volume indexes [PVI and NVI, respectively) at the bottom of the chart; see notes on Figure 1 for details), one arriving just as gold fever was approaching near-mania levels, it would pay for thoughtful traders to at least consider the possibility that this market may be going to pull back, possibly to the Fibonacci 23.6% support level (green shaded area) near 1251.00 before staging another run higher. When the NVI and PVI are both moving in the same direction, a strong trend is confirmed, but when they start to diverge from each other and from the price action on the chart, it pays to take note and prepare for some action on the chart in question.

We've seen it happen before (in 2004, 2006, and 2008) and this could be the start of yet another biannual gold meltoff, one designed to shake out as many weak hands as possible before going on to even higher highs. So be on the lookout for a gold pullback to the 1251.00 Fibonacci support, and if that doesn't help reignite a powerful rally back up toward 1400.00, expect gold to once again meet up with its all-important 12-month SMA somewhere around the 1210.00 to 1225.00 area (projected). Gold futures haven't even been near that moving average since May 2009, so perhaps this market just needs to blow off a little steam, pull back, consolidate, and then march on toward new nominal highs in 2011 and beyond.

Time, as always, will tell. For now, be very nimble if you do go long gold futures here, as the rallies could be deceptive and short-lived. If you see 1309.00, the October 2010 low taken out, consider looking for low-risk short setups, as that will constitute a key reversal monthly bar pattern that many professional traders will already be monitoring for possible completion. A break and daily close below 1315.20 would also be very bearish.

If things really start to disintegrate and the gold bulls start to panic, the big line in the sand is likely going to be the July 2010 low at 1158.00; this is not only key chart support, but it is also very close to a major Fibonacci confluence zone that runs between 1140.00 and 1147.00 area (pink shaded area). If this major support zone fails to hold, then we must assume that a major trend reversal has taken hold in the gold market.

One more technical aspect to consider is this: if you look at the charts for gold futures on a daily or even intraday basis since November 3, 2010, you'll see how nearly all of the gains made from that date until the November 9, 2010, all-time high have evaporated on this single thrust lower -- in only six days of trading. This implies that a corrective move is now under way, one that will at least take out the recent low at 1329.50, if not eventually meet up with at least one of the previously mentioned monthly support levels, with 1251.00 being the first major monthly support.

Bottom line, the gold market itself will decide how all of this plays out. The best we as traders and investors can do is to thoughtfully analyze our charts, keeping an open mind about the path of least resistance for this market after weighing all of the technical and fundamental evidence that we can.

What I've presented here is just one possible scenario, so keep analyzing your daily, weekly, and monthly gold charts with similar sets of indicators overlaid on them and see if you can't also find those rare but extremely profitable times when all three sets of charts lead you to arrive at your own high-probability set of conclusions for this or any other market you trade.

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.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
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Gold's Monthly Chart Warns Of More Downside

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