-- Posted Monday, 8 June 2009 | | Source: GoldSeek.com
By Howard S. Katz
Well, fellow gold bugs, the third time is the charm. This is the third time that gold has made an attempt to (permanently) breach the $1000 level., and this time it looks like it is going to make it.
This is also a good time to continue our discussion of technical analysis because the monthly basis chart of gold has two interesting chart patterns, the symmetrical triangle and the ascending triangle. And these patterns are telling us a great deal about the likelihood of a break of $1000.
A triangle is a chart pattern consisting of 4 turning points (a high, a low, another high and another low) such that the line connecting the two highs and the line connecting the two lows intersect to form the geometrical figure by that name (adding, of course, a third line to the left side of the chart). A symmetrical triangle is one in which the second high is lower and the second low is higher, and this gives one the sense that the market is building up tension for an explosion in one direction or the other. Reflecting this idea the symmetrical triangle is sometimes called a coil.
An ascending triangle is a triangle in which the second high is equal to the first, causing the top line of the figure to be horizontal. With the ascending triangle, we get the sense that there is an advancing demand (which causes the lows to be higher) but a flat supply (which causes the highs to be equal). What is going to happen when that advancing demand meets the constant supply? Clearly demand is going to win. When they identified the ascending triangle, the old timers were thinking of a very large operator who had decided to sell at a certain price. He was operating in the context of a bull market, which kept putting the price up, and he initially picked a sell price just above the market. His selling would knock it down. Then it would rebound back to the same level. Again he would sell, and again the buying would come in (this time at a higher level). When his selling was complete, the market would signal this by breaking above the old highs (the horizontal line). This told traders that the overhead supply was out of the way, and the basic bullish forces would regain control.
Both the symmetrical and the ascending triangles are called continuation formations because they predict that the price action after the triangle has broken out will continue in the same direction as before the triangle formed. (If an ascending triangle forms after a downtrend, then I disregard it because the above rules are self contradictory.)
The point where the two lines of the triangle intersect is called the apex. Most of the time prices make one final pull back to the apex after they have broken out. The symmetrical triangle in gold of 2006-07 first made a move up to $1000 and then pulled back to the apex at $680. Despite this important clue I always find such pull backs tricky and difficult to catch. They always seem to happen just after I have given up all hope of them. The name “symmetrical” comes from the fact that the two lines are (very roughly) symmetrical about a horizontal line drawn through the apex. Once a symmetrical triangle has made its pull back to apex, then the real advance is about to begin.
In either type of triangle, one can predict a minimum price objective. Take the line connecting the lows. Then through the top point of the triangle (first high) draw a line parallel to this. However, this must be done on a semi-log chart, or it will not work. The site www.timingcharts.com is a good web site for commodities which both allows you to select a continuation (near future) chart and also provides semi-log.
It should also be noted that volume confirmation is required for all bullish breakouts. This means an increase in volume on the few days (or weeks) surrounding the breakout. No volume confirmation is required for a downside breakout. A pick-up in volume is required for stocks to rise. They fall of their own weight. Volume confirmed nicely on the Sept. ’07 symmetrical triangle breakout. As for a coming ascending triangle breakout, we will have to wait and see. The site www.prophet.net is one of the few sites these days which still show volume.
Given this, what information do we have from our two triangles? Well, gold took off after completing the symmetrical triangle in September 2007. It made a powerful move up to $1000 (on March 17, 2008). The fact that it could go so far before making its pullback is very unusual and shows great strength. This also coincided with the minimum price objective line (not shown). The fact that gold could hit its minimum price objective line before completing its pull back to $680 also shows great strength. The chartist of the future will point to Oct. 24, 2008 and say, “here the real advance began.” We also note that the only serious decline that gold made during the 5 years shown on the chart was late 2008, a time when all commodities were hit badly. Thus it does not reflect anything wrong with gold but was rather a more general move which affected the whole economy. Finally, the fact that gold recovered its March 2008 high before any other economic good shows that it is the strongest of all the financial markets.
Of course, the ascending triangle has not yet broken out, but if it broke out tomorrow, then the minimum price objective line would be about 1600 (and rising). This indicates a very powerful move; this may be surprising, but it is backed up by other technical indications.
One of these indications is another classic chart pattern, the double top. This is market action which forms two high points with a low inbetween, sort of like the letter M. The two high points do not have to be at exactly the same level, but they should be close.
Below we see that the dollar has formed a double top. This will be complete when (if) it breaks down below the mid-December support at 78 ¾. Any important low which stands out on the charts acts as a support area because people commit the fallacy of the fair price. See the discussion in my April 20, 2009 article, Technicals I. The vast majority of people who trade the markets are always committing the fallacy of the fair price. This is why they are continual losers. They have failed to learn what Adam Smith taught, that there is no such thing as a fair price and that the only morally proper price is the price agreed to by a willing buyer and a willing seller.
Since Thomas Aquinas did not give clear criteria for computing what is a fair price, people who believe his theory calculate the fair price for a good by the price which stands out in their minds. It may be that they bought or sold at that price. It may be that the price traded at that level for a long time. It may be that the price is the highest or lowest in the good for quite a while. Whatever the reason, they regard this price as in some sense fair, and this influences their decision to buy or sell.
For example, in the chart above the price of 78¾ of mid-December stands out on the chart. Even if you don’t look at charts, then it stands out because it was the lowest price for some time, and it put an end to the sharp dollar decline of late autumn ’08. For these reasons, 78¾ is viewed by a great many people as fair/low. That is, one of them may say to you. “The dollar is in a range of 79-90; you can buy it at 79 and sell it at 90”. Another may say, “I shorted the dollar at 79 in December, and boy was I hurting. Here is my chance to cover at a fair price.”
When I was a young trader, I met a gentleman who boasted that he never took a loss. He bought a stock. If it went up, he sold it. If it went down, he refused to sell. Soon all the winners were sold out of his portfolio, and he was sitting with a long list of losers. These losers just kept going down. But this gentleman was not unhappy. He figured the stocks had to come back to their fair price, by which he meant the price he paid for them. Mostly that didn’t happen. A lot of people went broke on Chrysler and General Motors recently using the same theory. Actually, it is the opposite strategy – cutting your losses short and letting your profits run – which works best in the long run.
Aquinas invented the theory of the fair price in the 13th century. Smith refuted him in 1776. But most people don’t bother themselves with philosophical ideas. So they keep making the same mistake year after year and century after century. It is over 2 centuries since Smith wrote, and most traders do not have the slightest idea of what he said. That is why they are grist for our mill, and the smart technician can take their money.
Why is this important now? Because people are buying the dollar based on the fallacy of the fair price. They came in on Wednesday after the dollar had dropped below 79 (Sept. future) and bought heavily on Wednesday and Friday. Why were they buying? Because 79 was to them a fair/low price. The savvy technician knows that buying will come in at such a point, and he calls this a technical rally. He knows that it is only short term, and it does not upset his calculation for the longer term.
Assuming that the mid-Dec. low breaks, the double top formation will be complete in the dollar. By the way, such formations should only be observed in the near future’s chart. Different future months have premiums or discounts, which bleed off as the future approaches cash, thus giving their charts a different appearance. Chart patterns only work on the cash market. Often cash prices are not available to the futures trader, and in this case chartists construct a continuation (or near future) chart. This plots the nearest future until the day of its expiration; then it switches over to the new nearest future, etc. If we chart the Sept. ’09 dollar index future, then it has already broken its mid-Dec. low, but such a signal might not be valid.
A double top, when completed, gives a minimum price objective equal (in percentage terms) to the decline from the top to the breakout point (the low point of the M). For the U.S. dollar index, this would imply a decline to 69 – an all time low.
The larger event which is going on is the fact that the “deflation” scare raised by the media in late 2008 was basically false and is now in the process of reversing (in the manner of the snapping back of a rubber band). For the immediate future, pretty much every economic good is going to move in the exact opposite manner of late ’08. All commodity prices are going up, and the dollar is going down. This fundamental analysis confirms the technical analysis and gives us greater confidence.
How to play these expected moves is discussed in my newsletter, the One-handed Economist. For this you have to cross my palm with silver, 20 oz. of silver for a one year subscription to be exact. For those of you who are back in the age of paper money, we accept $300 paper dollars. However, if the dollar breaks 78¾, completing its double top, then we may raise our dollar price in order not to lose money.
If you want to get a sense of my writing, go to my blog at www.thegoldbug.net. Here I blog on political and social issues from an economist’s perspective. Currently, I am running a multi-part series, “Strategy for Victory,” in which I discuss the political strategy which should be used by the pro-liberty party to bring liberty in our time. This week is the third installment.
Thank you for your interest.
# # #
-- Posted Monday, 8 June 2009 | Digg This Article
| Source: GoldSeek.com
