A Technical Approach to Gold

Think oil is hot? When was the last time you took a look at gold prices? A glance at the 10-year price chart for spot gold on the COMEX shows a bullish “cup and handle” technical pattern. In fact, since declining to the $250 level in 1999, the trend has been extremely bullish with the price of spot gold touching a 16-year high of $458.70 in December 2004. The current major trend remains in place and shows no signs of letting down, although there is some selling pressure at $450. Since breaking $450 in late December, the commodity has failed to find a way to break higher.

 On the daily chart, you will see a major bullish double bottom that took form in June and July. Since the first bottom in June, the price of spot gold has advanced 8.43%. In last Thursday’s session (August 11), spot gold jumped $9 to an eight-month high. Spot gold is now trading above its key 20-day moving average of $431.13 and its 50-day moving average of $430.93.

 The catalyst driving up the buying frenzy was a combination of a weak dollar and increased inflationary concerns due to the surging oil price. The weak dollar makes gold more attractive for foreigners as gold is denominated in the U.S. dollar. But what is the upside for gold?

 I have heard some bullish gold traders (PROFIT CONFIDENTIAL columnists included) calling for gold to break $500 an ounce. Some extremely bullish gold bugs have even quoted $600 and $700 as potential targets. Now if you based the movement of gold on the technical picture, which is currently near-term bullish, $500 is reasonable if a strong break at $450 materializes. Now if you extend out the trendline, even $600 is possible. But whether it will happen depends largely on the gold fundamentals.

 Going back to 1980 when the price of spot gold touched $873 an ounce, inflation was running at a whopping 10% a year. Since gold is generally used as a hedge against inflation and uncertainty, it would take a major reversal in the current benign inflation numbers to drive gold towards the levels we saw in 1980. Instead I see gold trading at below $500 in the foreseeable future given the current environment. A sustained break at $450 would be the first step, but as gold moves towards $500, I do expect plenty of selling pressure to surface. Without inflation, the upside is limited.

 Sorry gold bugs!