By Donald W. Pendergast Jr.

12.13.09
So, we’ve seen a substantial correction in the Gold market over the past couple of weeks, and that means that Gold is now ready to rocket higher to fresh highs, isn’t it? Probably not, at least not right away, and patient and wise traders/investors will want to wait a bit to see what Gold does as it interacts with any number of key support levels. Let’s take a closer look, hoping to ascertain when/where this current downdraft might expect to meet up with major support.

Gold Weekly Chart

1. Metastock v.11
2. Metastock Profitunity (Bill Williams) expert advisor

The weekly chart of cash Gold suggests that the fresh wave of selling, although getting close to significant daily chart support (near 1100-1100), is very likely to keep heading south toward the more significant weekly support levels depicted on the chart above. Here are some of the key technical highlights:

1. The Parabolic Stop and Reverse system (J. Welles Wilder’s famed ‘ParaSar’ system), although still in ‘long’ mode, is getting precariously close to a stop and reverse (to short) signal (see the trailing string of ParaSar dots beneath the price bars). If it does go into short mode, existing speculative longs should consider closing their positions ASAP.
2. The spread between the 21- and 50-month exponential moving averages (EMA’s) is flattening out for the first time in nearly five months, confirming the loss of upside momentum.
3. The recent Commitment of Traders report from the CFTC suggests that commercial interests in the Gold futures market are still heavily short even as the large speculators (hedge funds and the like) are still overwhelmingly long. The action on the price chart means essentially one thing – the commercials are selling the large specs all the Gold they can handle, hoping to cover their short positions at lower prices in the weeks and months to come.

The Path of Least Resistance

While it is true that a market that has completed a move from $700 to $1,200 in the course of a year should be given every benefit of the doubt, the odds strongly suggest that the path of least resistance – given all of the aspects discussed above – in the Gold market remains toward lower prices. As shown on the chart, the next major confluence area of chart support, Fibonacci support and EMA support all converge near the area of 1070 to 1050. At that price zone we find the 50% Fib retracement of the July 2009 to December 2009 weekly upswing, along with the October 2009 swing highs (former resistance which may provide future support). Finally, we also find that the 21-month EMA also coincides with the same support zone. In other words, expect to see major weekly support near 1070-1050, followed by a tradable bounce on the daily time frame. I’ve taken the liberty of drawing a hypothetical ‘A-B-C’ corrective wave (purple zigzag line on chart), one that may be proportional to the size of the major up thrust that preceded it. While no one knows exactly how this correction will play out, this ‘projection’ of how prices may respond might help keep trader’s focus on the importance of keeping on the right side of this highly volatile market.

Finally, there is also a very strong support area spanning the range from 979 to 990; this one is also characterized by another ‘three-fold cord’ (which cannot be easily broken) comprised of the 79% Fibonacci retracement, the 50-month EMA and the September 2009 swing low. This could be a vital support area for Gold – a significant breach beneath it could really unleash a tidal wave of mindless selling that could take months to repair. Essentially, traders need to see how Gold responds as it meets the first support barrier (1070 to 1050); some questions they need to consider are these:

How far does Gold retrace the plunge from $1,215 before falling lower again? And if Gold moves sharply lower from the initial support level (1070 to 1050) down toward the sub-$1,000 level, just how panicked are the sellers as they unload their long holdings? Are the commercials eagerly scooping up Gold from these discouraged longs or are they waiting for more opportune prices at which to rebuild their long positions?

The current bottom line in cash Gold:

Expect a decline toward 1070-1050 before seeing a tradable daily-based long swing setup appear. Existing speculative long Gold positions should be closed out if the weekly ParaSar system goes into short mode. Aggressive traders might even attempt to go short on any bounces higher on daily and/or 30-60 minute intraday charts. If we see an eventual drop toward the lower support area of 990-970, those seeking to acquire more Gold for their long-term ‘core’ position might find that to be an especially attractive area in which to initiate further purchases.

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By Donald W. Pendergast Jr.
Technical Market Analyst

10.16.09

For more than two hundred years, the average of the Gold/Silver price ratio has been about 30 to 1, and more recently (since 1997) the ratio has been averaging about 60 to 1. The ratio simply means that it would take about sixty ounces of Silver to equal the value of one ounce of Gold. Interestingly, as of today (10.15.09), the ratio stands at 59.27, very close to the average ratio of the last twelve years. Let’s look at a price chart that covers that dozen-year period and see if we can’t make an educated decision about the probable direction for this critical ratio, and, while we’re at it, also seek to determine how to profit from the current trend in the Gold/Silver ratio.

Gold Silver Ratio Trading - CLICK TO ENLARGE

Graphic credit: Metastock v. 11

A Ratio in a Range

If you’ve been an investor and/or trader for any length of time, you’ve probably heard the term ‘go with the trend’ on more than one occasion. And, generally speaking, the ‘easiest’ (although successful trading and investing is likely to be the hardest ‘easy’ money you’ll ever make) times to turn a profit in the financial and commodity markets is to get on board a strong trending move during a periodic pullback against such a trend, letting a continuation move of the trend progressively increase the value of your investment. Now look at the chart above, one that depicts the monthly Gold/Silver ratio (cash price basis) since 1997. One of the most obvious features of this chart is the strong upper resistance line that connects the three most recent swing highs. The line encompasses the range from 83 up to 85 and suggests that this is the upper level for the Gold to Silver ratio, barring some unforeseen change in the fundamental characteristics of these individual metals markets. Now look at the lower portion of the chart and witness the strong area of support that exists between 43 and 45; a blue support line connects the two recent swing lows, suggesting that the ratio may indeed find solid support in that general range, should it continue to keep falling. For whatever reason, once these Gold/Silver ratio swings commence, they tend to keep going until they hit the prior area of strong support/resistance. Perhaps the current downswing will also follow suit, dropping back down toward the 45-43 area, which could be a major boon to Silver traders and investors everywhere.

Powerful Downswing in Motion

If you will, direct your attention now to the individual price swings, all of which have been highlighted with either a gold arrow for ‘up’ or a red arrow for ‘down.’ Note how that once a swing move (up or down) begins, it typically carries forward with a great deal of momentum, with most moves lasting from one to three years. The last complete downswing took nearly three years to complete, with the ratio declining from 84 all the way down to 44 – nearly a 50% decline. If you’ll recall, this was the period when Silver began a massive, multi-year bull move from a sub-$5 breakout pattern, and, even though Gold was also rising in tandem with the white metal, Silver’s move higher was far more dramatic in percentage terms. Now, shift your gaze over to the right side of the chart (also know as the ‘hard right edge’) and note the powerful downswing already in motion in the ratio; it’s already declined from 85 to 59 and with the same kind of intensity previously seen in prior downswings. If the length/duration of past swings continues to be applicable to this latest thrust lower, we may very well expect to see the Gold/Silver ratio test that lower support line within the next six to twelve months. And if the ratio completely breaks down, bursting below 43 on a monthly close, we might actually witness a new attempt of the ratio to drop down toward the long-term historical ratio of about 30 to 1. Clearly, in such a case, it would be far better to own greater amounts of Silver and the shares of Silver mining companies than it would be to own Gold or shares in Gold mining companies.

What This Means in Practical Terms

For the average investor, this chart has a number of practical uses. Since you have a choice of whether to allocate investment funds to Silver or to Gold, whenever you see a high probability Gold/Silver ratio trend in motion (as we have right now), and that the trend is moving lower, a wise investor would bias the bulk of his/her precious metals funds toward Silver rather than Gold. Since we know that the ratio has a high probability of trending lower for some time, a conservative investor might decide to put 35% of his funds to work in Gold and 65% in Silver. There are a variety of ways to purchase and store either of the precious metals, and, if you time your Gold/Silver ratio metals purchases wisely, you may do very well as the long-term bull market in these two metals continues to progress toward new highs. Those who simply desire to hold Silver by way of the Silver ETF (SLV) can use this chart to great advantage as well. Precious metals equity traders might simply bias their investing and trading activities toward the particular metal that is currently outperforming, focusing on the mining shares of the companies that mine Silver either as a by-product or as a primary mining operation. Since Silver is outperforming Gold, that might mean attempting to buy silver mining companies on normal pullbacks toward support. Since the future of the metals market is unknowable, however, it would also pay to trade/invest in Gold and Gold mining shares and ETF’s as well, just in case the ratio begins to reverse in favor of Gold at some point.

Spend some time every month analyzing the current state of the Gold/Silver ratio, a ratio that has served savvy traders very well for many, many years. Learn to put it to good use in your own trading and investing activities and see if it doesn’t also help fatten your bottom line as well.

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Mark Brown