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Gold In A Cup & Handle Formation at Trader’s Narrative

Since I’ve been a curmudgeon about the incessant rise of gold, I’m trying to force myself to look at the other side of the ledger. The last time we looked at the old relic commodity, it was to grudgingly accept that even if gold is in a bubble, it has quite a ways to go still.

Sentimental Fools
We looked at the cross-currents in gold sentiment in the middle of May. Since then my timidity hasn’t been incorrect. Price has retraced a bit and basically gone sideways. Now it has floated back to where we left it. Sentiment right now is still positive but not extremely so.

We have the anecdotal magazine cover stories (Thanks to Steffan, our trusty man from Germany) and Market Vane’s Bullish Consensus is still hovering around 70%. As well the gold closed-end fund CEF is trading at a 9.86% premium. Finally, the bullish percent index for the sector has collapsed from 77.4% to 52% (after falling to a low of 42% in late May). That means that gold stocks could enjoy a rally before becoming overbought.

And if you just can’t get enough of gold sentiment indicators, I pity you, fool! Then quit your jibba-jabba and check out the Mr. T Gold Indicator, courtesy of Minyanville.

Parabolic Goodness
While I’ve benefited from identifying the parabolic blow-offs in gold, I’ve missed out on what happens next. As you can see from the chart below, the recurring pattern after the parabolic tops has been a retracement and then a sideways range which forms a cup and handle technical formation.

Click to see a larger chart in a new tab:
gold cup and handle formations Jun 2010

Cup & Handle with Care
The formation can be a bit sloppy but the criteria for it is defined as a counter-trend retracement that lasts several months and takes prices down to the long term trend line. Price then recovers to the previous high only to then enter a second retracement that lasts a much shorter time frame and is much shallower.

The result is that resistance is eroded and the next upleg begins after a break above the previous high. This is similar to the view that Adam Hewison shares in this short 2 minute video about gold with a focus on the $1240 level to provide a potential breakout to the upside.

Bubble Target
The difference between a bubble and a bull market is that in the former you’re a spectator and in the latter you’re an investor. If gold is in a bubble, then it would still have to rise to about $3000 (give or take a few oz.) to equal the trajectory of other bubbles like the housing market or the Nasdaq tech bubble. That dovetails nicely with this chart, courtesy of David Rosenberg of Gluskin Sheff, showing the Dow Jones Gold ratio:

dow gold ratio long term chart Jun 2010

A true bubble top would take this ratio back to 2-3 where it has bottomed before - not inconsequentially at the end of secular bear markets. As well, parabolic blow-offs like the ones in the chart above are good short term technical signs of exhaustion but if we look at the long term chart of gold (say from 2000 to now) the trend is still very much linear. When this long term trend itself goes parabolic, then I think we’ll have a good indication of the end of the gold secular bull market.

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One Response to “Gold In A Cup & Handle Formation”  

  1. 1 Warren Peary

    There are two ways the Dow to Gold ratio could get back down to a major low: the Dow could drop precipitously OR the Dow could chop around while gold rallies significantly. The crowd that thinks government deficits will lead to currency collapse and inflation to pay soaring debts thinks gold will soar. The deflationist, Super Bears like Robert Prechter think the Dow will drop precipitously with gold going down less so. At 2,000 Dow, a Dow to Gold ratio of 3 puts gold at around 700 oz. This is also Prechter’s dowside target for gold.
    I’m with the deflationists due to my knowledge of how excess debt and the deleveraging cycle result in a shrinking money supply and a shortage of money to pay debt and less money being borrowed into existence by the private sector. Government debt issuance squeezes credit market interest rates up cutting off borrowing. This will only cause inflation if the world’s central banks completely change their policies or are dismantled so the governments simply print money to spend. Right now they do not do this. They have to sell bills, notes, and bonds.

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