Gold represents different things to different people. Some people only look at gold as an ornamental metal for use in jewelry while others consider it to be a form of currency. Some people consider it be a store of wealth and a means to protect against inflation.
Personally, I look at gold just like any other investment vehicle. It moves up and it moves down, it has patterns that repeat, and it is potentially forming a bullish pattern at this point.
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The pattern I’m talking about is an inverse head-and-shoulders pattern. If we look at the weekly chart of gold, we see it hit a low around $1,600 in October, forming the first shoulder. Gold then rose to the $1,800 level to form the left side of the neckline in November.
A pullback in late November and through December forms the head down at the $1,550 level and then a two-month rally brought it back to the $1,800 level to form the right side of the neckline. The pullback over the last few months has brought gold back down into the $1,600 range and could be forming the second shoulder.
In order for the pattern to be completed, gold will need to move back up to the $1,800 level and then break through the neckline. This would mean gold is challenging its all-time high up near $1,900. It is also worth mentioning that the weekly slow stochastic readings are at their lowest levels since December and their third-lowest level in the past three and a half years. In recent years, when the slow stochastic readings have dipped below the 30 level, gold has rallied 10% or more in the ensuing months.
Another factor that could drive gold higher is the current sentiment. For the sentiment toward commodities, the best measure is the Commitment of Traders (COT) report that is released by the Commodity Futures Trading commission each week.
The COT measures the net holdings of three groups: large speculators, small speculators and commercial hedgers. I like to watch the large speculators because these are the big boys that can move the market.
Gold is unique in that large speculators rarely are net short. In fact, I went back through the COT reports from 2003 to the present and large speculators have not had a net short position during this time.
Rather than worrying about whether they are net short or net long, it is better to look at how many contracts they are net long. Large Speculators have only dropped below 140,000 contracts long on a handful of occasions in the last three years. Each time they were holding fewer than 140,000 contracts, gold experienced a decent rally in the weeks that followed. The COT report for April 10 showed large speculators were net long 136,653 contracts.
While the inverse head-and-shoulders pattern hasn’t finished developing yet, the factors that are lining up for a rally in gold outweigh the bearish factors. Should gold drop below the $1,600 level, the odds for a further dip increase dramatically.
At the time of this writing, Rick Pendergraft does not own any gold-related securities.