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FEINT!
by Brian Bloom
beyondneanderthal.com
September 8, 2007

Last week the gold price rose by $30. Let me admit up front that I did not see it coming. When it comes to trading, I am not as smart as I would like to be.

Fortunately, I also understand that ego can be a killer in any market. So, my attitude is this: You were wrong Bloom. Get over it. Suck it in and move on. Let’s turn to a fresh page and look forward.

The questions now uppermost in my mind are: “Was the $30 rise in the gold price the genuine article? Was it a knockout punch or was it a market feint?

The evidence seems to point to the latter – for the time being.

Last night I watched a program called ‘Lateline’ on TV. An Australian economist was being interviewed, and he made three points amongst others:

1. There is currently a credit crunch in Australia because banks are reluctant to lend to one another
2. Short term interest rates are spiking
3. In an effort to reliquefy the money markets – so that the credit crunch does not spill over to the rest of the economy – the Australian Reserve Bank has broadened the number of assets it is prepared to buy from Financial Institutions, to include mortgage backed securities.

Okay, so let’s look at the markets with some perspective. Let’s look beyond the trading ‘noise’ to see if we can pick up any hints of what might unfold in the medium term.

First and foremost, if the gold price rises to a level above $715, it will represent a believable ‘buy’ signal. The reason that $715 is so important flows from the chart below (courtesy stockcharts.com):

Whilst the ‘vertical’ count target on this chart is $810, the horizontal count target is $715. The horizontal count target is a ‘trading’ related target which flows from a breakout from a sideways trading consolidation. The vertical count target flows from the underlying power of the market which can take an indeterminate amount of time to manifest. If the $715 target is penetrated on the upside, the $810 target will increase in its significance.

What can we expect in the foreseeable future if the $715 target is broken?

The less sensitive chart below shows a vertical count target of $1,403; and a horizontal count target of $749 (15% above $651.56 – the point of breakout)

What can we expect if the $715 level is not broken?

This same less sensitive chart shows that the price will hit what is know as a ‘double top’. A double top is bearish. $749 should be looked on a ‘guide’ to future possibilities only if the double top is broken to the upside

One key issue, in this analyst’s view, is whether gold is to be viewed as a commodity or a currency. To answer this question, we need to look at the relative strength chart of $Gold:$CRB below.

There is no question that the chart below is in a bull trend – but it is showing a triple top. If this is broken to the upside it will be very bullish. If not, it will have bearish connotations. The reader’s attention is drawn to the previous double top that manifested in early 2006.

Gold has without doubt been outperforming commodities – but it has not yet broken to a new high.

Even on the less sensitive chart below it has not yet broken to a new high.

So the $64,000 question is: Will the above two charts break to new highs?

This is where the water becomes a bit muddier. Life is not as simple as it seems.

The chart below of the $CRB (also courtesy stockcharts.com) is showing a fairly worrying bearish formation

There has been a clear breakdown from a rising wedge. Following the breakdown, the price has pulled back up to the resistance of its 40 week Moving Average. The 20 week Moving Average line is pointing down. All this is consistent with a genuine breakdown.

Can this wedge be aborted? Of course it can! Anything is possible. But let’s look at some implications if there has been a genuine breakdown from a bearish formation. (And let’s try to stay away from the hyperbole of hyperinflation vs depression. There are other points along the spectrum of possibilities)

In context of a credit crunch, the issue of “price” of money becomes subservient to the “availability” of money. The Central Banks can flood the money markets with a tidal wave of money, and they can drop the price of money to the floor. The key issue, in this analyst’s view, is will the banks lend in future to consumers with questionable credit ratings? In my view, this will not happen. That’s why the Australian Central Bank is choosing to emphasise asset purchases rather than loans to the Private Banks in order to liquefy them. The Central Bank is not looking to “drive” the economy at this point. It is looking to put a safety net under it.

The next question is: Will credit worthy clients of banks borrow money for “frivolous” pursuits like buying a boat or a second home or a bigger plasma screen TV?

In my view, there is a nervousness brewing whereby consumers are likely to become a lot more circumspect. How do I arrive at this view?

This photograph appeared in Sydney’s Media on September 10^th 2007. 

Hard sell: A mortgagee in possession auction of a Susan Street, Annandale
home passed in without attracting a single bid yesterday. Photo: Jacky Ghossein

In the USA, in pockets across the country, signs are starting to appear outside houses where the mortgagee in possession has put the house on the market.

This is not “theory”. This is the reality of what is happening to Mr & Mrs Joe Sixpack. And their friends are watching. And the level of caution, if not fear, is rising.

One can only assume that another reason The Australian Reserve Bank is prepared to buy mortgage backed securities is that it wants to avoid these mortgagee in possession sales. But people are not generally stupid. An increasing number of ordinary consumers is experiencing difficulty in making ends meet. That, in this analyst’s view, is why the commodities chart is breaking down. The world economy is facing a slow down.

What are the other charts saying? Is the market generally yet reflecting this conclusion?

The fact is that the charts are mixed. Some are bullish, and some are bearish. But, in this analyst’s view, the leading charts are turning increasingly bearish, whilst the lagging charts are still bullish.

Here is an example of a leading chart, courtesy Bigcharts.com

The chart of Citigroup – one of the world’s largest Financial Institutions – is giving an OBV sell signal, and it has broken down from a diamond formation. (No, Diamond Formations are not always reversal patterns). The main fact which this chart has got going for it is that the price is far away from its 200 day Moving Average. It “should” pull back up again.

Can the breakdown be aborted? Of course it can! But right now, the diamond has broken down. That’s the signal.

On the other hand, the chart below is arguably a lagging chart. 3M is one business that will probably only begin to feel the effects of a recession down the track.

This is a strong chart, but there are a couple of indications that investor attitudes may be changing:

• The recently rising prices have been on falling volume. (Not a bullish development)
• The MACD is turning down
• There is an uncovered gap at the 78 level. Most gaps are eventually covered. Exceptions to this rule are “gap island reversals”, “breakaway” gaps and “runaway” gaps. As this particular gap was not followed by a second gap, it cannot be categorised as a breakaway gap and it certainly was not part of a gap island reversal pattern. The probabilities are therefore high that it will eventually be covered.

In this analyst’s view, the reason the markets are still holding up is that there is a US election in the offing, and the markets are being (artificially) supported. I therefore cannot see a ‘collapse’ in the offing.

Now let’s get back to the main subject of interest: The Gold Price. Will the gold price break up relative to commodities and will it become viewed as a currency – a safe haven against a collapse? (Which I am not yet ready to accept is inevitable because the charts are not calling for a collapse.)

The chart below (courtesy Decisionpoint.com) is a monthly chart, and the reader’s attention is drawn to the gap – the one that caught me by surprise.

The $64,000 question is: Will this gap be covered?

Looking back to 1985 there is not one single gap on the monthly chart that has not been covered in the past 22 years.

Could this be an exception? Of course it could! It could turn out to be a breakaway gap.

This implies that the breakaway gap will be followed by a runaway gap as the price of gold ‘screams’ up.

What are the conditions required for it to ‘scream’ up?

Well, clearly, the market will need to experience a panic of some sort. Something will need to happen which spooks the market. If this does not materialise, then the odds favour the gap being covered.

With at least one Central Bank (Australia) being prepared to overtly support stupid commercial decisions of Private Enterprise – by announcing that it is prepared to “liquefy” mortgage backed securities – the world is being sent a message. “We, the Central Banks of the World will fight against a coming depression with every breath in our bodies”.

So, any reason that a panic will materialise will be unlikely related to economics. This leaves politics.

If something happens out of left field – for example, if Iran or Syria or Osama drop a bomb somewhere – then a genuine financial crisis might manifest. Barring that, it seems likely that the Central Banks will continue to fight against Gold being perceived as a currency.

Conclusion

Whilst the Central Banks remain in control of the world economy, the likelihood of a financial crisis to drive the gold price to new heights seems small.

However, the markets will have the last say. If the gold price rises above $715 an ounce, we will very possibly experience a panic of some nature, and an accompanying runaway gap – which will cause the gold price to scream up.

Unfortunately, if the $715 level fails to be penetrated, the gold price is likely to pull back sharply as disappointed stale bulls bale out.

Right now, because the gap on the monthly gold chart is the only one in the last 22 years which has not (yet) been covered, and because the Central Banks are demonstrably prepared to support the markets at all costs, the probabilities favour a pull back.

The probabilities favour the conclusion that the $30 up move in the gold price over the past week was a ‘feint’.

As always, if the markets dictate otherwise, I will change my view.

Disclosure

© 2007 Brian Bloom
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Brian Bloom
Beyond Neanderthal
Sydney, NSW, Australia
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