While everyone’s attention was on a head and shoulder pattern completing on the Standard & Poors 500 index, another head and shoulder formation was taking place in gold. As the magical $1000 marker acted as strong resistance several times, a consolidation pattern emerged below it.
Here’s a good video update of the recent price action. Click the chart below to watch the video:
While head and shoulder formations are usually considered to be reversal patterns, they can also act as continuation patterns. This is less common and fewer technical analysis students know about it, which makes it more likely to complete. As we’ve all noticed by now, the head and shoulder formation in the equity indexes was noticed and watched closely by everyone and their uncle. Which is why it turned into a bear trap.
The other possibilities are that we could get an irregular head and shoulder pattern. This is a variation where the shoulders are not symmetrical. For example, we could have two shoulders form in the right hand side. The whole pattern would still be valid but it would take longer to play out.
Also, we could see a sideways trading range which would then suggest a large cup and handle pattern instead. Either way, if the price of gold continues to trade within a short distance from the $1000 resistance, the probability of it breaking up increases.
Finally, we can look at the K-ratio to get a sense of the gold market. This is a ratio of the gold equities compared to the price of gold itself. It was first proposed by the technical analyst Jay Kaeppel and I estimate it by using the Philladelphia Gold Index (HUI) and the futures price of gold - instead of the original formula of Barron’s Gold Mining Index and the Handy & Harmon price. There is a minor difference in the two but the important thing is keeping things consistent by picking one method and sticking with it:
According to the K-ratio, the best time to buy gold stocks was in late October 2008, when they were almost as cheap as they were back in 2001. Of course, we now know the 2000-2001 era as a generational opportunity to buy gold - just as the majority were preoccupied with the technology sector. You can also see that the 200 rate of change for the ratio was confirming the buy signal. Right now they are both in neutral territory. This presents a bullish opportunity because if the price of gold breaks through the long term resistance, the K-Ratio still would have room to move up before becoming overbought.
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