Gold and Silver Market Updates
Jun 5, 2006
At a time like this it is important to stand back and review the big picture, in order to see how the current action fits into the big picture. In a nutshell, gold is in a steep downtrend within a larger uptrend. There is thus little doubt that it will go up again, so the questions are when and from where.
On the 6-month chart the larger uptrend is evidenced by the rising moving averages, and the larger uptrend will be considered to remain in force at least as long as the 200-day moving average is climbing. The present steep downtrend can thus be compared to a child running down the up escalator in a department store - it can be done, but it requires a determined effort, and the escalator is going to prevail in the end. There are two factors, however, that suggest that the corrective phase is likely to run gold back to the strong support in $560 - $575 area before it's done. These are the wildly overbought extreme that gold attained before reaction set in - normally such action signifies exhaustion of the intermediate uptrend that experience shows is followed by a lengthy reaction back to the vicinity of the 200-day moving average, necessary to flush out speculative excess and set the stage for the next uptrend. However, the 200-day moving average is still some way below a zone of strong support shown on the chart, which it very unlikely that gold will breach. In Technical Analysis there are frequent "convergences" - at turning points various factors come together and their collective strength is what turns the market. The convergence that is expected to halt this reaction and turn gold back up again is the point where the 200-day moving average rises up into the strong zone of support, an event which is currently 4 to 6 weeks out, and thus gives us a timeline to work with.
To expect gold to remain in the current steep downtrend all the way down to this support is asking too much. This is too tidy - too obvious. As Elliott wave devotees know only too well, countertrend moves in bull markets are often comprised of 3 waves, 2 down and 1 up in the middle of the move. We've just had a steep decline to the 50-day moving average, the support at which frequently generates rallies, and so it is probable that a short-term rally will arise from here, which will be believed by many to be the start of a new uptrend taking the price to new highs, but much more likely is that it is the B wave of an A-B-C correction, which will eventually be followed by further decline back towards the support at $560 - $575. This B wave, which can be expected to be cruelly deceptive, may take the price to say $675 before the C wave decline sets in.
In the light of all this the current position of the gold stock indices is most interesting, and we will now consider the 6-month HUI index chart below. From a trading standpoint this chart now looks most encouraging. Moving averages are in decidedly bullish alignment and a small base area appears to have completed between the moving averages, in a similar position to the March intermediate base area, although in this instance the preceding steep decline puts a different complexion on things. The MACD indicator is about to rise up through its moving average, and the histogram has shrunk back to the zero line, a situation that frequently precedes a rally. With the index having closed on Friday very close to the 340 line defining the top of the small base area that has formed over the past couple of weeks, the index is believed to be poised to break above 340 and rally sharply, a view which is reinforced by the index having marked out no less than 3 candlestick hammers over the same period. A breakout by the HUI above 340 would be expected to coincide with gold breaking out of its steep downtrend channel. Any such move should be sold as the stock indices approach their May highs, as implied above, before renewed decline sets in.
The dollar weakened significantly on Friday and now looks set to test its May low as gold makes its B wave up. After that it is likely to rally strongly which would be expected coincide with the C wave down in gold, silver and PM stocks.
What are the chances of gold not marking out an A-B-C correction as described here and simply storming ahead to new highs? While such a development would be very unusual at this stage, anything is possible in markets and we cannot rule out the prospect, although fundamentally it would probably take something like a sudden worsening of the Iran situation (by, for example, Israel carrying out air strikes) to generate such a move.
Just as you don't stop a speeding 100 car train and set it going in the opposite direction at the same speed in a split second, it times time to bring a powerful uptrend to a halt and turn it into a downtrend. A reversal pattern is believed to be forming in silver that looks set to generate a downtrend, although here it must be emphasised that this is an intermediate reversal, not a long-term reversal, and so the larger uptrend should eventually reassert itself, once the corrective phase is complete.
On the 6-month chart we can see how silver found support at its 50-day moving average for about a week, but that this support failed last week leading to further retreat to a strong and important support level above $11.50. We can further see how the action from May through to the present has marked out what looks like the left Shoulder and Head of a potential intermediate Head-and-Shoulders top - the break to new highs in mid-May turned out to be the top of the Head forming. The weak rally in late May might be the right shoulder forming, although it is not clear whether this is so because it is so small - if it is, a breakdown below $11.50 could happen almost immediately. However, given the situation in gold, where it looks likely that a B wave rally will occur, to be followed by a C wave decline to new lows to complete the corrective phase, it seems probable that silver will rally from here to mark out a larger right Shoulder, before retreating once more and breaking down below the key $11.50 support and plunging to complete its correction near its 200-day moving average, over a timeframe of perhaps 1 or 2 months, with silver bottoming, of course, at about the same time as gold.
If this scenario is correct, then the the right way to play silver is for aggressive traders to be long here, but in any event exit immediately on any break below $11.50, and to sell on the next rally to the $14.00 - $14.50 area, should this occur within the next 2 or 3 weeks, and then be ready to swoop and scoop it up in quantity should silver go on to break below $11.50 and plunge back towards its 200-day moving average, which is what can be expected if the price breaks down from the potential Head-and-Shoulders top formation. At that point the speculative froth will have been skimmed from this market and the stage will be set for another sustained and substantial uptrend.
Jun 3, 2006
Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge, England. He now lives in Chile.
Visit his subscription website at clivemaund.com. [You can subscribe here].
No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.