Gold is looking overbought in the short-term and could correct lower to $630

By: Clive_Maund

We have seen the breakout predicted in the last Gold Market update, although so far subsequent gains have been modest as gold continues to be restrained by the strong resistance level shown on the 1-year chart in the $655 - $680 zone. Although we have seen limited gains so far following this breakout, it was nevertheless an important technical development that is viewed as marking the start of a major uptrend which is still in its infancy.

The open question now therefore is whether gold will go on to break above $680 soon, which would be expected to lead to a rapid run at last year's highs in the $730 area, or whether it will first react back towards the third fan line, which happens frequently after a breakout from one of these 3-arc fan patterns.

Gold has had a significant runup in the 5-week uptrend that began at the early January lows, and is now substantially overbought as shown by its Stochastics, making it vulnerable to a short-term reaction, especially as it is still in a zone of strong resistance, which would actually be a positive development in a sense, as long as it didn't go too far, as it would unwind the overbought condition and thus put gold in better position to stage a convincing breakout.

The RSI and MACD lines are not seriously overbought, on the other hand, and given that an overbought condition as shown by Stochastics can persist for a considerable time, gold may just go ahead and break above $680 soon anyway, overbought or not. Should gold react soon it is important that it does not break below the 3rd fanline and below the upper trendline shown on the long-term chart below. At this point in time these lines are crossing at about $630, with the 200-day moving average just beneath, making this an important support level where we would expect the price to find support on any short-term reaction.

On the 6-year gold chart we can see its entire bull market to date, and how it accelerated dramatically in 2005, implying that if anyone was attempting to suppress gold, they weren't making a very good job of it. After the big rise from mid-2005 through May 2006, gold was entitled to take a breather, hence the subsequent reactive phase which only ended with the breakout from the 3-arc Fan Correction a few weeks ago.

While more aggressive traders will want to watch out for a short-term reaction, the bigger picture is that gold is believed to be on its way again, short-term reaction or not, and longer-term investors can safely ignore such minor fluctuations - only in the event of the upper trendline shown on the 6-year chart failing would they have reason to consider standing aside.

The dollar is worth taking a look at here as a resolution of the current standoff in the dollar will likely determine whether gold breaks higher or reacts back to the $635 area.

After its sharp runup early in January it was hardly surprising that the dollar ran out of steam where it did, as it had into 3 powerful restraining influences, its downtrend channel line, its falling 200-day moving average, and an important resistance level. As we can see on the chart, the intermediate uptrend has collided with the long-term downtrend. Normally this situation resolves with a break to the downside, but with the 50-day moving average turning up beneath the chances of an upside breakout are increasing, although not by much.

This situation needs to be closely watched as a breakout one way or the other appears to be fast approaching - gold and silver are rather out on a limb now and should the dollar break higher here, it can be expected to run to the next resistance level, an event that would be expected to trigger a gold reaction back to the $635 area. Agile traders will clearly want to take appropriate measures in the event that the dollar breaks higher.

The interpretation here does represent a shift to a somewhat more cautious stance near-term than that presented in recent articles.

By Clive Maund
CliveMaund.com

The above represents the opinion and analysis of Mr. Maund, based on data available to him, at the time of writing. Mr. Maunds opinions are his own, and are not a recommendation or an offer to buy or sell securities. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis. Mr. Maund is an independent analyst who receives no compensation of any kind from any groups, individuals or corporations mentioned in his reports. As trading and investing in any financial markets may involve serious risk of loss, Mr. Maund recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction and do your own due diligence and research when making any kind of a transaction with financial ramifications.

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