Copper is forming a bearish head and shoulders pattern after breaking out to a new high, forecasting an increased risk aversion in the global financial market.
Note that the pattern is confirmed as prices have not broken the neckline shown in the copper chart. If confirmed, the pattern is extremely bearish for the metal and can signal a reversal of the bull market phase. There is one key fundamental reason why copper turned bearish. The countries such as India and China, where demand for copper is high, are raising interest rates to curb inflation. This has a negative effect on copper prices.
However, let us look at the chart of copper. It has clearly formed the left and right shoulders as well as the head. Now the break of the neckline will confirm the bearish pattern. Traditionally, the US equity markets follow the direction of copper and the global markets follow the direction of the US equity markets. However, this time around, it is the Indian and Chinese markets that sold off before the US markets. But, if the US equities follow copper, it will provide bearish pressure on global equities. The break of the neckline of the copper index can take it to 454, which is the first support area, followed by 437 and 400.
However, keep in mind that a failure of the head and shoulders pattern can lead to a strong rally up. The first sign of a failure is when prices close above right shoulder, which is then followed by a close above the head.
Crude oil
Everybody’s attention is focused on crude oil, given the rally and the turmoil in West Asia. The light sweet crude futures contract traded on the NYMEX has been on a steady uptrend since May of 2010 and finally broke out of its resistance level of $101 last week. The next target for crude is the $112 level followed by $125. After that crude has a clear path with no major resistance till $140.
While the charts show bullishness, one must not ignore the fundamental factors which look bearish. Most central banks are hiking interest rates which can cool commodity prices. Copper is already showing signs of cooling. Additionally the spike in oil is due to the turmoil and prices can fall if the crisis blows over. Hence it would be advisable to play cautious on oil.
Since no one knows what will happen fundamentally one should look at the charts for guidance. If not long on oil, it is best to wait for a pullback to support, before buying. The first area of support is $101 followed by the $95 level. After that the next level of support would be at the $87.50 level.
Right now the chart of crude is looking bullish, which is understandable when prices rally sharply. The rally sometimes traps a lot of buyers if price crashes and hence it's best to wait for a pullback to enter at a better price with lower loss potential.
Gold
Since October 2010, gold entered a consolidation phase and also given a few fake outs, trapping break out traders. It did make a new high last week, but that did not lead to a rally and may be another fake out. We believe gold will continue to rally, but for now it's consolidating in what is called a broadening range formation.
In a broadening formation, prices make higher highs and lower lows, thereby broadening the price range. A higher high is when new high in price is higher than the previous high and a lower low is when the new low in price is lower than the previous low. This makes trading difficult for breakout traders as well as support and resistance level traders. Breakout traders enter when prices make a new low or high only to see a reversal in the opposite direction. Support and resistance traders enter at support and resistance levels only to see prices drop or rise a little more, stop them out and then go in the direction predicted in the first place.
Gold has done just that since October. It put a low of $1,320 on October 22, 2010 and then a new low of $1,308 on January 28 upsetting plans of breakout and mean reversion traders. On the upside gold made a high of $1,429 on November 9, 2010 followed by a higher high at $1,435 on December 7, 2010 and another higher high at $1,447 last Friday.
Gold traders should trade cautiously and long term investors still have no reason to sell.
The author is based in Chicago and is the editor of www.capturetrends.com
