Wednesday, January 12, 2011

Technical Analysis Shows Gold Is Not In A Bubble

The argument made by Charles Hugh Smith, as webbed by AOL Daily Finance, is chart-based and makes sense. He uses the charts not to prognosticate, but to show how gold's been performing so far. Since it advances in waves, and pulls back recurrently, Smith concludes that it's not in a bubble.
This is an interesting moment in the gold market. On the one hand, Goldman Sachs has raised its one-year target for gold to $1,650 an ounce, about $275 higher than the recent price of $1,375. Other analysts, though, believe gold is tracing out a classic speculative bubble, much like real estate did in from 2002 through 2007.

The proper starting point for technical analysis is agnosticism: Don't place any faith in either "story," but instead look to charts of price and other indicators for evidence one way or the other. It's remarkably easy to find evidence for a position you've already taken, but this "confirmation bias" can prevent you from taking advantage of technical analysis's potential to aid in making investment decisionss.

Let's start with a one-year chart of SPDR Gold (GLD), a gold exchange-traded fund (ETF) that's commonly used as a proxy for gold.

What we notice first is that gold -- at least over the past year -- has tended to advance in 3-month bursts, meander in a multi-peak topping pattern for several months, and then decline for a month or so to support levels. Then, it has resumed its long-term trend higher.

Rather than providing evidence of an expanding bubble, this chart suggests a healthy uptrend that has been repeatedly tested as it drops back to its support levels. Each time those levels held, then gold began another leg up. When the price of GLD dipped below the 50-day moving average, that signaled near-term weakness -- a slump that is further confirmed by a break in the trendline....

There's no blow-off bubble as of now, but there may well be one. Gold was similarly well-behaved in the late 1970s, pre-blow-off. It was so well-behaved, the late Harry Browne used a chart of gold from 1976 to early 1979 to show a real-life example of a classic uptrend (newer high followed by a descent to the older high.)

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