Gaps are typically signs of high emotion in a thin market when brokers are instructed to buy "at best", and are forced to bid the price up to secure supply. This may be sign of an absence of sellers rather than a presence of buyers but, in gold's case, we cannot be sure because volume numbers are not published.
Careful scrutiny of the weekly gold chart below (courtesy DecisionPoint.com) shows that - three weeks ago - the gold price gapped up through the resistance level of the upper trendline as it shot up briefly to well over $525. The following week the gold price retraced its steps to below the trendline (thereby covering the gap) and, this week, the gold price has once again gapped up through the same trendline.
What does this mean?
Gaps occur at psychologically important points, and the following are some examples of when they occur:
A common denominator to most of the above is "emotion" as opposed to "logic".
Most gaps are subsequently covered as the market finally comes to its senses regarding underlying "fundamental value".
There are two exceptions to this general rule:
So, the question arises: Is the gap on the weekly bar chart above based on emotion or logic?
The following factors need to be taken into account:
Clearly, according to conventional technical analysis, there is a justification for arguing that the gaps are based on emotion.
But what about the "structural change" argument?
Surely, if demand manifests when it usually abates - and it manifests repeatedly (evidenced by two gaps) it could be argued that this is ipso facto a sign of a structural change?
In this analyst's view, the issue revolves around fundamental value in general and, in particular, the thorny arguments surrounding gold's fundamental value.
Fundamentally, gold is one of those rare objects that has more than one paradigm of value assessment.
On one hand, it has value flowing from supply of and demand for industrial uses including jewellery. Based on this paradigm, demand at this point within the calendar year will undoubtedly be waning and the price of gold should be falling.
On the other hand, it has a "perceived" value based on its apparent stability as a currency of last resort. When faith starts to waiver in Fiat currencies, the demand for gold rises.
The most important Fiat currency in the world is undoubtedly the US Dollar. The US Economy accounts for roughly 25% - 30% of world GDP, and many, if not most, international transactions are denominated in US Dollars.
Logically, it therefore follows that if the gold price were to be rising because of a structural deterioration in the way the market perceives the "integrity" of the US Dollar, we should be seeing a deterioration in the price of the US Dollar relative to all other currencies - including gold.
The following are the daily, weekly and monthly charts of the US Dollar Index:
Clearly, based on all three charts, the level of 90 is significant from both a support and resistance perspective. Going back to 1988, 90 was a support level. In 1990, the 90 level was penetrated on the downside, and it took until 1997 for this level to be convincingly penetrated on the upside. Here we are in 2006, and the US Dollar Index appears to have once again reached a decision point. Will it break up above the 90 level or will it fail to do so?
The position is hardly clarified by the daily and weekly charts which appear to be in stark contrast with each other:
The oscillator on the daily chart is pointing to further short term upside potential, whilst the same oscillator on the weekly chart could be argued to be in intermediate term overbought territory.
But there is a paradox here.
Why would the US Dollar Index be showing strength at the same time that the gold price is showing strength? Surely such a state of affairs is contra-indicated?
A "technical" answer lies in the following chart of the Goldollar Index:
Three important observations flow from the goldollar chart above:
The trained chartist's eye sees a higher probability of consolidation at this level - with the most likely outcome being a consolidation of the US Dollar (possibly a slight rise) and a pullback (temporarily) of the gold price within a bull market for the Goldollar Index.
What does that word "temporarily" mean?
In the context of the "scale" of the chart, and the distance of the current goldollar index price from its rising trendline, it might take anything up to 12-18 months for the emotion to dissipate.
Having said this, the very fact that the Goldollar Index is in a bull trend has some important connotations:
How can this be? Blind Freddy can see we are in deep doo doo. The Fed is manning the printing presses, the US Government is in deficit (and debt) up to its eyeballs, the real estate market looks like it has peaked, private debt is at historically stratospheric levels. On top of this we have the risks associated with Global Warming, and of a possible outbreak of Bird Flu. Furthermore, China is experiencing growing pains as evidenced by more than one industrial chemical spill, and Mr Putin's economic adviser has just resigned because he believes that the Russian economy is no longer free of external interference.
Yes, all this is true, and yet the following chart of the NYSE Index is showing no signs of fear, and is not overbought relative to historical levels from an oscillator perspective.
Logic dictates that there is one (and only one) conceptual scenario that can validate why both the US Dollar Index and the Gold Price are rising:
The market is anticipating a buoyant economy, and the associated demand for gold will rise in the face of slowing supply.
Let's examine the one other argument that could be put forward as an explanation:
The Fed has printed so much money that it has nowhere else to go other than commodities (including gold) the stock markets, the property markets, and the bond markets. Prices of all assets - world wide - are rising on a sea of liquidity.
Whilst this may indeed be a contributory cause, it defies logic that in addition to the price of all dollar denominated assets rising, the price of the US Dollar as expressed in other currencies is also rising. It is for that single reason that there has been so much bearishness regarding the US Dollar.
And yet THE MARKET appears to be taking a different view relative to the US Dollar. The level of (approximately) 90 seems to be offering some strong support.
Is it possible that The Market is sensing a structural improvement in the world economy?
Because it is the Silly Season, and people are in a relaxed frame of mind, the following joke can appropriately be put forward as a humorous attempt to crystallise the core issue:
At one end of the spectrum there will be those people who are adamant that the World Economy must implode, and that it's only a matter of time. They will find the above joke funny, but a bit unnerving. After all, we are apparently defying the laws of Nature.
At the other end of the spectrum there will be those people who genuinely believe that mankind has progressed to a level where, through the emergence of such revolutionary progressive understanding related to DNA mapping and Nano technology, we are ready to break through historical barriers to human progress. They will find the above joke irrelevant.
In the middle of the spectrum there will be those people - like myself - who struggle to have a balanced view, and can embrace the concept of scientific evolution sitting alongside the concept of "Intelligent Design" (To be perfectly PC). They will argue that the two views as articulated above are not mutually exclusive.
It is these people who will be open to the idea that, maybe, this time around things are really different, and that The Markets have not taken leave of their senses.
The evidence seems to be pointing to the following conclusions:
My own view is to play it safe. I am not relying on an improving economic environment, but will be not be at all surprised if it manifests. Indeed, I am behaving in all areas of my own activities (except listed investments) as if the economy is about to improve, and I have at the same time put a safety net under me. I have a significant investment in gold and silver related counters, and this is giving me peace of mind to go about my normal day-to-day activities. In the event that the economy implodes, my investments in gold/silver will protect my capital base. In the event it grows, the demand for "precious metals" for industrial applications will grow with it.
It's called a win/win scenario, and that's comfortable.
Happy New Year to all
Sydney, December 29th 2005