Suspicious Reversal In The Gold Price

Gold moved lower early during yesterday’s session, but came back up later. Finally, gold ended the session only $3 lower. Can we view such a reversal as a bullish sign? Not necessarily. A valid reversal should be confirmed by high volume…and yesterday’s session wasn’t. Consequently, one needs to look at other parts of the precious metals sector for confirmations.

The above action, however demonstrates bearish signals. Let’s start with the USD Index chart (charts courtesy of http://stockcharts.com).

Gold had a very good reason not to decline more – i.e. the USD Index edged higher…and then gave the gains away. The important thing, however, is that the support line remains intact. Consequently, the outlook remains bullish.

As we said earlier, gold reversed, but the volume that accompanied the reversal was relatively small. This suggests that it wasn’t really a “reversal”, even though the price action may suggest so.

At the first sight it may appear that technical phenomena like reversals or breakouts are just more or less random names for more or less random price movements without anything that justifies changing the outlook based on any of them. In reality, these are simple terms that refer to phenomena that are indeed happening in the market -- and that were subsequently found to be usually followed by some kind of action. If enough of the reliable factors are seen, the outlook may indeed change.

In case of reversals, the thing that the single candlestick on the chart represents is the situation in which one side (bulls or bears) attempted to push the price in one direction and got almost or mostly overwhelmed by the other side. If both forces equal each other, the price will not change in terms of daily closing prices (or weekly closing prices, which was more or less the case with gold last week). Now, if the price had been falling previously - and we saw this kind of action, it means that the selling pressure was no longer significant enough to trigger further declines. And at the same time the buyers were stronger than previously. Consequently, the implications would be bullish. Conversely, if the price had been rallying previously and we saw the mentioned kind of action, it means that the buying pressure was no longer significant enough to trigger further upswings - and at the same time, the sellers were stronger than previously. The implications would be bearish.

The key thing here is for the above to make any sense, there really has to be some kind of “fierce battle” between buyers and sellers. If there was none, we couldn’t speak of one side overwhelming the other - and thus there are no bullish nor bearish implications. How can we tell, whether one side really overwhelmed the other? By looking at the volume. High volume confirms the above as it suggests there were high numbers of both buyers and sellers who participated in that session. Conversely, low volume suggests there are little implications in this session (in terms of viewing the reversal as important).

With the above in mind, let’s take a look at yesterday’s volume. It was relatively low. Consequently, it doesn’t appear that yesterday was the session when the sellers and buyers were fighting hard to push the price of gold in a given direction. Instead we saw a move lower and a corrective upswing shortly thereafter. Instead of being bullish, yesterday’s session was rather inconsequential by itself.

In the case of silver, however, we saw a decline in volume that we hadn’t seen in weeks. Consequently, while gold’s reversal wasn’t confirmed, silver’s decline was. Hence, the implications are bearish.

The volume wasn’t as huge in the case of mining stocks. However, it wasn’t very low either…although the size of the move is quite visible. Gold stocks continue to underperform gold, which is a sign that lower prices are likely to follow shortly (not necessarily today).

Summing up, the invalidation of the breakdown in the USD Index and the decline on strong volume in silver have bearish implications for the precious metals sector in the short-term, while yesterday’s reversal in gold doesn’t have bullish implications.

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Przemyslaw Radomski, CFA

Founder, Editor-in-chief, Gold & Silver Fund Manager

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