Chasing Gold
by Carl Swenlin
October 24, 2008

When stocks started falling out of the sky, there were many analysts who urged people to buy gold. While this seemed to be good advice for about one or two weeks, gold's longer-term problems reasserted themselves, and prices began falling once again. The longer-term problems can be clearly seen on the chart below. Like many commodities, gold had been rising in a parabolic pattern that had become near-vertical, and parabolic rises almost always end in grief. As you can see, gold has already violated the top two rising trend lines, and is almost certainly headed for much lower prices. I do not rule out $300 as a downside target.

When so many were recommending gold during the initial market panic, a look at the gold charts would have provided sufficient evidence to prevent acting in haste. The next chart, which we just added to our "Gold Sentiment" page, can also help to alert you to when sentiment in gold is getting too bullish.

Central Gold Trust (GTU) is a closed-end mutual fund, which means that it trades like a stock on the NYSE. The fund owns only gold -- the metal, not stocks. Closed-end funds trade based upon the bid and ask, without regard to their net asset value (NAV). Because of this, they can trade at a price that is at a premium or discount to their NAV. By tracking the premium or discount we can get an idea of bullish or bearish sentiment regarding gold.

Note how recently people were paying a premium of over 20% for GTU. That means that for the share price and the NAV to become equal, the price of gold had to rise 20% or GTU shares had to drop about 20%. Unfortunately, as you can see, it was the latter scenario that evolved. Combined with a drop in the price of gold, GTU shares dropped about 29% to bring the share price and NAV back to parity. It is certain that many who buy GTU do not understand the basic principals at work on the price, and that buying when the premium is high is not such a great idea.

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A quick look at the stock market shows that we are going nowhere in an interesting way; however, that is not likely to continue, because a descending triangle pattern has evolved and a breakout or breakdown should be forced soon. Last week I said that the market was very oversold and that a sustained rally was likely. The fact that this hasn't happened yet is bad news. The fact that the October 10 lows have not been violated is good news, but that support forms the bottom of the triangle, and the technical expectation is that prices will break down through that support. (The horizontal side of the triangle is the weakest.)

Bottom Line: A few weeks ago I stated that I was not predicting deflation, but I see now I was not thinking clearly (at all?). We are already experiencing severe deflation in stocks, housing, and commodities. What more evidence do we need that deflation is the dominating force in the economy?

The oversold market conditions make it unwise to open short positions, but it is also a bad idea to position for a rally before prices break higher in a convincing way (whatever that means). In any case, if we get a good bottom around here, I will assert that it most assuredly is not the end of the bear market.

We rely on our mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your tactics and strategy if conditions change.

BIO: Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.