Gold and Silver Testing the Waters
What a Battle!
Last weeks price action in the price of gold has been very painful and concerning to many gold bugs (gut wrenching!). Many are wondering if we have reached a major top in gold? Are the mining stocks going to come back? What about Bob Prechters bearish forecast? Could gold bugs be wrong? Certainly the gold market is a special breed, arguably more volatile and emotional than the Nasdaq.
Before I get to the main part of my commentary I would like to revisit briefly last week's chart of July 19 where I identified a flag formation.
In Chart 1 below you can see a close up of the second flag. All indications were green for a bullish breakout from this second flag. Then on Friday afternoon after uploading the gold futures contract data I noticed that the volume was only a paltry 17,000 contracts! Only 17,000 (see indication in Chart 1 below) I asked around for confirmation of this volume, as my initial thought was that it might have been bad data because it seemed so unusually low. This is extraordinary low volume especially with respect to the previous 3 months as a comparison.
As it turned out the volume was indeed valid. And the indication? The indication was that this breakout was a major head fake! This +6.8 price move and gap was not to be believed! And it makes sense actually with the luxury of hindsight. Flag formations that are formed at the end of an extensive advance (in this case since early 2001) are to be watched with major suspicion. Secondly this supposed flag's formation is at the enormously important 22-year resistance level. So again, in hindsight it makes sense that a small flag like the one in Chart 1 above is simply not enough price work to get us past the 22-year resistance level.
It is likely that the day after this anemic volume breakout, a huge short position was being built up by the pros and technicians who saw the low volume breakout and pounced on it.
The main point I would like to make here though is regarding the overall perspective. Five straight days of plunging prices in gold to someone who follows the market on a daily basis is very scary indeed. But, (and you will hear me repeat this again and again) those interested in the gold sector need to keep their perspective focused on weekly, preferably monthly time frames. Long-term trends are not established with 5 days of price action.
I cannot blame people for focusing most of their senses on this past weeks 5 days of 'horrific' declines. Yes, its hurts. Most, if not all people (including me) focus their thinking on what is for dinner tonight and what the plans are for the upcoming weekend. It is only natural. However, in terms of markets, one needs the flexibility to orient thinking in terms of months and quarters so you can better keep the daily declines in perspective. I am not talking about the old 'buy and hold for the long term' mantra. I am talking about being able to orient and adjust your thinking to a monthly or quarterly time frame and keep that at the top of your mind. Then these daily declines make lots of sense and even seem necessary.
The best way to accomplish the frame of mind is by looking at the longer-term price charts and then stare at them for hours at a time. It sounds silly, but in fact I do believe it is one of the best ways to build confidence in the longer-term trend. Realistically though, in addition to staring at the chart for a long time, one needs to gain a true understanding of why the prices are moving the way they do (the psychology and momentum behind them). In fact, a good understanding of the basic laws of physics is indeed very useful to the chart practitioner.
Chart 1
Testing the waters
Do you remember those days when you were a kid at summer camp a long time ago, and you went down to the dock on the lake to dip your toes into the water by the dock to see if it was too cold to jump in and swim? Well you were testing the water to see if it was worthwhile to swim in or not. Too cold? Well then better not jump in but rather stay on the dock. That's what this golden bull is doing, finding its comfort zone. It is a necessary and valid market dynamic to 'test the waters' below it to see if the golden bull trend is indeed valid.
Now the KEY question for our purposes is will the golden bull just dip its toes or entire foot into the water to make its decision? The market will have to decide that. I cannot. I can only outline possibilities.
But again, testing is important. And that is precisely what last week's daily price action was, testing. This golden bull simply cannot afford to have weak hands on its eventual return and challenge of 330, the 'ultimate battle line' (See thick white line in Chart 2 below). Think about it, would you want to attempt to break through the earth's atmosphere in the space shuttle with only a half way competent crew and only one solid rocket booster (SRB) ? I didn't think so, and the golden bull doesn't either. The golden bull is trying to shake out as many weak longs as possible before it tries to attack 330 again. The golden bull will need as much forward thrust as possible to break through the next 'battle line'. And it will need to be accompanied by strong consistent volume. It will be the ultimate signal of strength and conviction. In Chart 2 below note that I have drawn in a yellow hypothetical volume line, which would be consistent with the rounding bottom trend, which I firmly believe, has developed.
Lets look at Chart 2 now a bit more in detail. It is a monthly chart and the most important thing to recognize in this chart is the rounding bottom trend. In other words, prices are moving in what appears to be the early stages of a parabolic move (trend lines that are at increasingly higher degrees of slope).
In all the stock chart patterns that I follow I would have to say that rounding bottom type formations are my favorite. Why? Because the implication is that as time moves on, one can expect greater rallies with shorter pullbacks until the trend reaches its first major peak.
The rounding bottom formation is representative the fact that market participants only start to become more confident in a market trend as it rises higher and higher. The evidence for this is also reflected in the volume pattern, which also exhibits a rounding bottom pattern below. What is interesting with regard to price trends in general is that one will often find that certain stocks and indices over time tend to repeat their price characteristics. The golden bull of the 70's exhibited rounding parabolic type price patterns culminating in spectacular peaks. So that is the 'personality' of the gold market. I see this personality showing itself again now and hence my conviction that a new gold bull has been born.
The other thing to note in chart 2 below is the resistance and support line marked X. I see that line playing an important role in combination with the up sloping rounding bottom line. Where will it stop? We have to let the golden bull tell us where it wants to stop. It is possible it could be 300 as on my daily gold charts I see a very oversold level. But one cannot rule out the possibility of a move to before the golden bull feels solid footing. There are some levels, which, if broken would put this entire long term up trend in doubt. At this time those levels have not been breached on any time frame.
How long will this test take? Early indications are between 2 to 3 months. This is consistent with the long-term chart of the US Dollar (not shown here) where I see that the US Dollar has found support on its long term up trend line. It is likely to trade in a rectangle, which could support the broader market averages in a run to their head and shoulders necklines.
Chart 2
Hi Ho Silver!
Now for a few brief words about silver starting with Chart 3 below which is the most current chart of silver. Line B is now good support. Line A was the level of long term supply and resistance and hence is good explanation for the 'gut wrenching' pullbacks we have seen in the silver market as well as the mining stocks. The yellow arrow is the sweet spot of support and mirrors to some degree the trend in gold. Note also the rounding bottom pattern of volume consistent with the overall pattern in the gold market. The 2 red circles mark the fantastic surge in both price and volume to get us above former resistance B.
Chart 3
The beginning of the 'old' silver bull market
Below in Chart 4 is the beginning of the silver bull run in 1971, 1972. If you look carefully at the chart you will begin to some similarities to the current silver price action. Again there is resistance line A and support line B. The two red circles mark the surge in volume and price to get above resistance line B. Note the red price bar that has fallen back to support B below, a similar situation to what we see happening in Chart 3 above. Note also below the rounding volume pattern.
Chart 4
The Bottom Line:
Major bottoms in any market are indicated by rounding bottom formations. In fact I would go so far as to say that we are likely to see some rounding bottom formations in the Nasdaq and other major market indices in the years ahead in their bottoming processes. We are still in the early stages of this rounding bottom for gold and silver. We are not at a major top in the gold or silver market; on the contrary we are early in this longer term up trend.
Thomas R Carreno
July 30, 2002
Thomas R Carreno is a self-taught market technician with over 8 years experience analyzing stock, index, and commodities charts. Tom specializes in finding market divergences that offer the highest probability trades over intermediate and longer-term time frames. His new website, BestOnlineTrades.com is a newsletter oriented Technical Analysis site that is currently devoted to covering most popular gold stocks. Email: 
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