Gold and other precious metals are on the recovery trail, with investors worldwide growing
after the massive injection of capital by world governments fighting the credit crisis. The emerging rally is gathering momentum, but massive resistance lies overhead, near gold's historic high just above $1,000.
Of course, the yellow metal is also a fear hedge in these times of economic peril and instability. However, that emotional factor is likely to ease by the second half of next year as economists and analysts further quantify the levels of toxic debt worldwide as well as the impact of the colossal stimulus measures.
The last leg of gold bull market began in the summer of 2007, when the futures contract rallied out of a yearlong basing pattern at $700. The subsequent uptrend added more than 40% to the metal in the next eight months, with the instrument finally topping out at $1,035 in March of this year, right at the peak of the
The subsequent decline dropped the contract down to support at the basing pattern, where it bounced strongly in October. The uptick since that time has retraced nearly 62% of the March-into-October decline, with the metal now testing the $900 level. Notably, this price level turned away the last recovery effort four weeks in a row back in October.
This barrier also converges with the declining-highs trend line in place since the March high. Taken together, it's likely the gold rally will stall soon and give way to an extended consolidation phase, or even another selloff wave. For this reason, gold players are advised to book profits or protect long positions with tight stops.
The pattern since March also shows an expanding wedge, which is a high-risk formation because downside exposure at resistance levels -- like $900 -- can be quite painful. In this case, the contract could drop all the way to $650 and not affect the pattern. However, I doubt that will happen because three selloffs since the high predict the correction is finally over.
Alternatively, we rarely see a V-shaped rally back to a major high at the end of a long correction. Instead, back-and-fill action, with a series of higher lows, often sets the stage for a stronger recovery many months after an actual low is posted. I suspect that's what we'll see on the weekly gold chart through the first half of 2009.
With this in mind, I'm looking for a trading range between $750 and $900 that persists for three to six months at a minimum. That sideways grind would establish a decent basing pattern for an eventual assault on the $1,000 level. The consolidation might also correspond with stabilization in world growth that would, in turn, reintroduce inflation pressure.
Silver has traveled a more difficult path than gold in the last few years. The contract's long bull market stalled well short of the historic high near $800, posted in the early 1980s when the Hunt brothers tried to corner the market. However, just like gold, its upward trajectory ended in March, with a swift pullback into the summer, followed by a vertical descent.
Price bottomed out near $85 in October, with price chopping higher in a weak rally into December. So far at least, the contract has failed to press above resistance at the 200-day moving average. This mediocre progress predicts the recovery effort will eventually stall out and give way to a test of the lows, perhaps as early as the first quarter of next year.
The structure of the decline also raises red flags as we head into 2009. Note the vertical selloff between March and May, followed by a weak bounce into July and a much steeper decline into October. This price action is carving out a perfect Elliott 5-Wave pattern, in which the latest bounce marks a fourth wave countertrend ahead of a major selling climax.
The last leg of the long downtrend is likely to match the March-into-May decline. This yields an eventual downside target between $60 and $65. Notably, that level would correspond with the broad boundaries of a 2004-2005 basing pattern. So, my recommendation to silver bugs is to ease out of positions and wait for a better entry.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
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