Tuesday, July 31, 2012

What My Trading System Says About Gold Right Now

Gold appears to be breaking out of a narrow trading range and could finally be ready to deliver gains to traders again. At least that’s what the chart and my 26-week rate of change (ROC) system are telling me right now.

Last week was the SPDR Gold Trust's (NYSE: GLD) narrowest weekly trading range in more than 18 months. The trading range is defined as the difference between the highest and lowest price seen in the week. Eventually, low volatility gives way to high volatility, and that happened this week when gold broke toward the upper limit of a three-month consolidation pattern.

GLD has traded mostly between about $148 and $158 a share for the past three months. The chart below shows that GLD should be expected to break out of this trading range and move higher.

GLD Chart

In the middle of the chart, a flag pattern has been highlighted in blue. This pattern appears on many charts during large price moves, usually at the halfway point. The measured move based on this pattern pointed to a low of about $150, close to the actual bottom of the trading range. Because GLD has met its downside price objective, I believe the decline in gold has reached an end.

After breaking out of the trading range, the price target for the move is equal to the size of the trading range. In this case, a $10 price move is expected to follow, and that would bring the price of GLD to $168. That price is also the apex of the triangle pattern, which would be a price level expected to offer resistance.

In addition to price patterns offering a number of reasons to look for at least a small gain in GLD, relative strength (RS) analysis offers another argument for a bullishmove.

At the bottom of the chart, GLD’s performance relative to iShares Barclays 1-3 Year Treasury Bond (NYSE: SHY) is shown. This ratio shows whether gold or short-term Treasury notes are preferred by investors. Since GLD reached an all-time high last year, investors have generally preferred SHY to GLD. As GLD touched the lower edge of the trading range, the RS ratio formed a slight bullish divergence, and it has now broken the downtrend line. Previous trendline breaks have been associated with at least short-term gains in GLD.

It seems appropriate to use SHY as a benchmark for a RS analysis of gold. The metal is considered by many to be an alternative to cash, while SHY is a virtually risk-free alternative to cash. If SHY is outperforming GLD, traders should sell GLD and accept the risk-free rate of return from short-term Treasuries. When traders’ appetite for risk increases, or global uncertainty points to an increased demand for gold, the RS of GLD turns higher.

By following the RS analysis, we don’t need to know which factor is pushing traders to GLD. We just need to know we will own it as long as it’s going up, and we’ll sell when it stops going up.

That’s the essence of my 26-week ROC strategy. We want to be in the strongest ETFs in each asset class.

1 comment:

  1. Great explanation about this trading system.I also agree that metal can be considered a good alternative to cash.