Gold bulls need to proceed with caution as the bullish precious metal has entered an overbought zone rallying more than 20 per cent from a key average. The 20 per cent snap away from the average has led to correction in gold since the great recession of 2008.
The recent drop in the stock market led to panic gold buying pushing prices to all time highs over $1,800 per troy ounce. We are looking at the mini-sized gold contract (Symbol YG) traded on NYSE Liffe. Prices that move far away from their mean prices often revert back to it.
There are several ways to measure how overbought prices are. We will look at two and both show that gold has run up too far too soon. One of the strengths of the gold chart was that the rise of the precious metal has been steady. It is difficult for prices to fall rapidly, if they moved up slowly. As prices rally in a steady and sure fashion, it creates a lot of demand areas along the way. Consequently if prices fall back to demand levels, they tend to rally.
However, after the August panic of potential defaults in Europe and the credit downgrade of US treasuries, we saw a sharp drop in equity prices and rally in gold as investors sought safe havens to park money. The price of gold stretched away from its mean, where historically there has been a correction. Long term investors use the 30-week moving average on a weekly chart to see the trend of the market and the distance of price from the average to check if the market is overbought or sold. Since the beginning of the great recession in 2007 gold has rallied 20 per cent higher than it’s average three times. Two times gold sold off and let’s see if history repeats itself this time.
The first time gold rallied more than 20 per cent above the average was in March 2008. It sold off to fall by 34 per cent over the next few months. The second time gold did it again was in December 2009, which led to a correction of 15 per cent. Last week gold again rallied 20 per cent higher than the average. It also sold off strongly indicating selling pressure and let’s see if prices fall further. At the very least, this is not the time to buy gold.
The other indicator that shows gold is overbought is the Bollinger Bands. The bands measure the deviation of prices from a 20-period moving average. The bands above and below the average measure two standard deviations and if prices rally above the upper band it shows an overbought condition. Last week when gold prices hit an all time high of $1,800, the upper band was in the $1,700 range. We are looking at the weekly chart. Even on August 15, at the time of writing this article prices were at $1,765 with the band at $1,725.
Usually when prices rally too fast, they fall back to the mean. At the time of writing the article the 20-period average was at $1,565 and the 30-week moving average was at $1,512. When looking at the mean one should remember that it would move higher in the coming days given that gold is bullish.
Gold is still bullish given the long term uncertainties of the global economy. However, it’s best to wait for gold prices to fall before going long as prices have rallied too far too soon.
The author is based in Chicago and is the editor of
www.capturetrends.com
