Wednesday, May 27, 2009

How High Gold?

Given the incredible Fed money printing, gold is going much higher. How high? It is impossible to put an exact number on it, but I am certain most forecasts are underestimating how high gold will go.

Bob Murphy asked me to take a look at the charts on gold to see what the price action in gold is looking like. Here's what I found. (I hasten to add that there is a lot of mumbo jumbo in the technical world and that the only technical analysis that should be used is that which is grounded on an analysis of human action.)

Gold is currently trading just under $1,000 an ounce. Near round numbers, especially a number like 1,000, there is always a lot of technical resistance before a stock or commodity seems to be able to break to higher levels. This is because a lot of traders set their price targets at the round number, "Oh, I will sell my gold and take a profit at $1,000."

A second resistance point is a previous high. For gold it is roughly in the $1002.80 to $1030 area on the futures exchange. But at the daily London fix, gold still has not traded above $1,000. So we can safely say that once gold at the London daily fix is above $1030, that gold has broken through all overhead resistance. The resistance at old highs occurs pretty much for the same reason resistance occurs at round numbers. There are traders who will say, " I sold last time at price X (the old high) so this time I will also sell at X and buy it back later at a lower price."

Now lets look at the charts. Both the one year chart for gold and the five year chart show reverse head and shoulders formations (on the five year chart the formation is roughly a three year formation). If you look you can see that the formations look like an upside down head and shoulders. The book Technical Analysis by Edwards and Magge explains in detail the behavioral action behind the cause of this formation. But for purposes of this post, I'll just point out that the right side of the formation shows that buyers are willing to pay up a bit more for gold during downtrends and thus each new low is higher than the previous low.

This is a very powerful formation because it sucks out the sellers overtime and puts gold into the hands of strong holders, i.e., holders who are not going to sell for a quick profit but are much more willing to hold for long term gains. Again, see Edwards and Magee for details on how I am making this conclusion.

Once a breakout is made above the head and shoulders formation, the move upward is generally very strong, couple this with the round number breakout at $1,000 and the new high breakout, just above $1,000 and you have a lot of technical forces set to push gold much higher. And given that Bernanke has been printing money at double digit rates to fuel the rise, I would not be surprised to see days when gold trades up by $100 an ounce. I am not going to put an upside target on gold because it depends a lot on what Bernanke does from here. That said, $2,000 gold is very likely and $5,000 is not going to surprise me, if it gets that high.

No comments:

Post a Comment