Tuesday, August 16, 2011

Dave Blais: History Suggests Gold is Topping Out Soon

Today The Crude Oil Trader would to introduce Dave Blais. David recently left a six-figure salary to trade the markets full time since his real passion is gold and silver stocks. We have great respect for Dave’s insights, and the fact he backs up his insights and philosophies with his own money. Here's what Dave is thinking this week........

Gold has been on an upward tear lately – no surprise given the uncertainty over how the western world will deal with its debt. What could be a surprise for investors (but mostly traders) is that history suggests the odds are high that gold will top for the year sometime in the next three weeks.

A feature of the current gold strength is it is happening in the heart of summer, a time when gold is usually weak. Though rare, this "out of season" strength in gold has happened before. When it does, something interesting occurs, gold makes a top that will not be bettered for the rest of the year, in August or early September.

In the last 30 years, gold has had only two summers with the type of outsized gains gold is making this summer (a rise of about 20 percent or more). In both cases, gold topped out for the year on either side of Labour Day.

In 1982, gold had a surprisingly strong summer – rising more than 50 percent – and gold topped for the year in early September. The news then driving the gold price was the threat of a Mexican debt default … sound familiar?

londongold1982
In 1990, gold had another unusually strong run in the summer and was up almost 20 percent, which is closer in magnitude of the current rise (up about 22 percent when gold briefly topped $1800). That summer run in 1990 topped out in late August, and gold did not exceed that top during the rest of that year.
londongold1990
In 1990, gold had another unusually strong run in the summer and was up almost 20 percent, which is closer in magnitude of the current rise (up about 22 percent when gold briefly topped $1800). That summer run in 1990 topped out in late August, and gold did not exceed that top during the rest of that year.
There are other factors hinting gold will need to take a breather soon.


Of note, the gold mining shares are not confirming this rise in gold. Take the bellwether gold mining stock Newmont Mining for example. As of this writing, Newmont is still wellbelow the high of $65.50 it made last year, even as gold is hitting new record highs day after day. This is a potential warning called "divergence" that should not be ignored.

nemont gold
Overall, Canaccord Genuity research shows that the senior and intermediate gold stocks in their coverage universe are discounting a gold price of $1,409 per ounce.

Then there is the curious chart for gold that is making what looks like a “blow-off” top.

The current chart formation for gold is eerily similar to that of silver’s chart when it went into a terminal rise earlier this year. That steep rise in silver quickly gave way to a punishing decline that knocked some 30 percent off the silver price in a matter of days. In turn, the stocks of silver miners were pounded.

goldversussilver 3

These types of blow-off tops are usually not sustainable – and they don’t tend to end well because of what causes them. The rapid rise we are seeing now appears to be fuelled in part by a “short squeeze."

Fundamentals like the debt crises in Europe or the recent downgrade of US debt can explain some of the factors behind the rise, but the news is not the sole cause of this fast, wild part of the current rise.

Wrong-footed traders who made a mistake by going short (betting on a decline in price) in a big way– are being forced to buy back gold to close (or “cover”) their short positions that have gone horribly wrong as gold relentlessly rises. Their urgent buying of gold to close their short positions (and cut their losses) causes the gold price to rise further, causing more shorts to cover in panic, creating a feedback loop, and a price spike, that may quickly exhaust itself.

That a short squeeze has been evident in the gold market lately, in particular, after gold recently broke above $1680, has been noted by some market watchers who monitor the trading of gold future contracts. Ed Steer, who publishes Ed Steer’s Gold and Silver Daily for Casey Research, commented in his August 13 bulletin: “the open interest numbers were indicating for the reporting week, the rally in gold was pretty much all caused by short covering.”

Short squeezes tend to end abruptly when the short covering finally exhausts itself.

If gold does turn tail soon, how far could it fall? A good target for a drop is the area that has held anytime gold has declined during the last two and a half years, its 150 day moving average. Currently gold’s 150 day moving average stands just below $1500/ounce.

History is a guide, not a bible.  But there are some recent and longer term charts that suggest the gold price could top out in the next few weeks. And of course, long time gold followers know it's just at times like these, when excitement is running high, and everybody thinks they know what to expect that gold turns tail, and breaks the hearts, and wallets,  of the unwary.


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