The gold bull market started on the 3rd April last year, after gold was fixed at $256 on the day before to make a double bottom. Fourteen months later, on June 4, the PM fix was $328, for a gain of 28%. And for all practical purposes, that was it.
Since then we have seen the gold price trapped in what is developing as a large triangle, now entering its sixth month. The top of the triangle now lies just below $326, with the last time that level has been challenged some three weeks ago, during early November.
Triangles on occasion develop right into the apex, but more often than not the break takes place some time before the apex is reached. This means that the gold price has to make a move within the next 2 months and probably within the next 4-5 weeks at most. If that move should be a break higher, as happens with about 90% of triangles, what is the kind of move one could expect?
In technical analysis, triangles deliver a ‘count’ – an estimate of what the reach out of the pattern is likely to be. Most triangles are located on a ‘flag pole’, the term used for the trend that is in place when the triangle develops as a consolidation pattern with that trend. It was found that the subsequent move out of the triangle generally are of the same extent as the length of the flag pole on which the triangle is suspended.
This ‘count’ applies to triangles in a bull market as well as to triangles in a bear market, where the ‘flag pole’ is upside down.
For the gold price, the flag pole is in effect the full move of the bull market, from April 2001 to June this year, during which the price moved from $256 to $328. This gives the flag pole a ‘height’ of $72 and the extent of the new bull trend to come – if the break does take place upwards from the triangle – should be equal to this amount. The question is what starting point to use for the calculation of the target level.
Tradition seems to have it that the count begins from the point where the price breaks out of the triangle into the new trend. In this case, that would be from the $326 resistance at the top of the triangle and the target then becomes $398.
Perhaps a little more conservatively, there is a view that the count should begin at the start of leg 5, the final leg within the triangle that leads into the break higher. For gold that would be $310,80, where the current leg 5 of the triangle started, in which case the target lies near $383.
For the pure technician this is practically an open and shut situation – the gold price is in its triangle, it has started on leg 5 with the move higher from $310 on October 17th, and in due course – within say 5 weeks or so – the break higher from the triangle will take place and the gold price will gain approximately $72.
Fundamentally, though, one would like to know what would trigger the break higher – if that is going to be the direction of the break. Secondly, seeing that such a strong ceiling has been imposed on the price around the $325 level, what does a break higher imply for whomever is responsible for the defence of that level. Market action in the US has clearly indicated that the ceiling is artificial and not a matter of straight supply and demand.
Firstly, given the way that Comex futures are being used to place a lid on any rise in the gold price that breaks above $320 to approach $325, a clean break higher can only occur when the spot market de-couples itself from the futures market, so that the latter no longer exert such an influence on bullion itself. That means that physical demand for gold must spike higher; buyers must no longer retreat when futures are being off-loaded on Comex, but stand firm and take on sellers of bullion who have habitually reacted to the arbitrage potential of the futures selling by buying the futures and selling gold.
When that happens, and buyers retreat, the paper market is dominant. However, should the situation arise where demand is large enough to take on the sellers of bullion and ask for more, the dominance is reversed, and it is the futures market that has to adjust to the gold price. Stubborn buying may well draw more supplies of gold out of the vaults of the parties who are concerned about a steep rise in the price of gold, which means there has to be a widespread and sustained demand for gold to really force the issue.
In turn, this means that whatever event or development sparks the new demand for gold has to be of a sufficiently dramatic nature to induce lasting feelings of great apprehension and insecurity among global investors, else their gold buying will again wilt under an increased supply, as has happened so often before. There are a number of guesses one can make regarding such an event or development – from a war in Iraq (or elsewhere?), to another act of ‘alternative’ warfare to a financial crisis as some or other bank or financial institution collapses. Or whatever.
Under normal circumstances and given the kind of resistance that exists for gold near the $325 level, one would rate the odds of a break higher as rather small.
But then, we are not really living under normal circumstances at the moment.