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Gold Signals: A Sell-Off Is Due

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by , 10-19-2010 at 11:30 AM (956 Views)
Real-time Monetary Inflation (last 12 months): 0.2%

Sometimes I feel like Cassandra. Gold's flashing "sell-off" signals, but a lot of speculators seem not to care. Allow me to state my case.

First, let's look at the technical picture.

Gold's Relative Strength Index (RSI) has been in overbought territory since Sept. 6—to date, 22 trading days.

RSI measures a market's strength or weakness. A high RSI, e.g., above 70, suggests an overbought bull market. For gold now, here's the kicker: its RSI trend has been diverging from its market price trajectory since Oct. 7. Simply put, metal prices have been moving higher, but the RSI has failed to follow suit. This points to an impending break in the price trend.

The wobble in bullion's strength is confirmed by its price skirting its upper Bollinger band.

Bollinger bands connect price points two standard deviations above and below a commodity's moving average. Wider bands bespeak greater market volatility; narrower bands indicate relatively stable markets, but it's the divergence that's the important thing. Gold's new price highs are touching the upper volatility band but the upward thrust isn't being confirmed by an upturn in market strength.

The icing on the indicator cake, if you'd care to characterize it as such, is a downward reversal in gold's momentum oscillator. The "oomph" in gold's upward trajectory is fizzling.

So what of fundamentals? Well, let's put aside monetary policy and longer-term metal dynamics for a moment to concentrate on near-term fundamentals—the demand and supply for gold contracts.

Normally, it's commercial dealers and institutional investors that move gold's price. Over the past two weeks, however, the gold futures market has been moved by speculators. This past week, it was small specs cranking up their net long positions by 9.8 percent while commercials and money managers essentially neutralized each other. The previous week, it was large, noninstitutional specs that ruled with a 20.8 percent jump in net long positions.

Even with this week's goosing, the length of speculative positions in the gold market was shortened by 4,411 future contract equivalents, the first drawdown in the past 10 weeks.

All this points to gold's near-term price vulnerability. Now, we're not talking about a wholesale reversal in gold's fortunes. The prospects of another round of qualitative easing still loom large, but cyclically, the market's ripe for a give-up.

To what degree?

Well, it depends. A close under spot's 10-day moving average at $1,352 today would be a first step to a breakdown, but a dip under last week's lows at the $1,341 level would be a stronger signal.

Assuming a sell-off occurs, the target for shorts (and the potential buy-in for bulls) would be the 50-day moving average—today at $1,273, and, if breached, the 200-day average—now at $1,188.

Moving averages are just that—moving. So, to keep abreast of potential cyclical bottoms, stay tuned to this column.
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