Gold passes test and still has room to run

Gold passes test and still has room to run

Gold has broken out and the metal is now in a full bull sprint. According to the author of the article, if you are holding gold or gold stocks, the best trade is no trade until the next test occurs. The author believes that gold and gold stocks will continue their price climb.

By L.A. Little
Sept. 12, 2012, 7:45 a.m. EDT
Market Watch

Approximately one month ago, I penned my inaugural piece on MarketWatch focusing on what neoclassical technical analysis is all about. The same day, I happened to publish a piece about Royal Gold and the coming breakout in gold stocks on Minyanville.

The point of this latter article was that a head of steam was building under gold stocks, and they looked ready to explode higher. Royal Gold RGLD -1.08% was positioned as one of the best pure plays in the space and was exhibiting momentary weakness.

As you know now, gold stocks and Royal Gold broke out in royal fashion! On that note and with the shiny yellow metal in a full bull sprint, I thought it timely to use neoclassical methods to map the current supply and demand zones, for it is the test of these zones that reveals information to the trader and a test appears imminent.

In the daily chart below (short term time frame) you can clearly see the anchored support zone that has formed on spot gold XAU -0.74% .

It is the intersection of all those large spikes in volume that correlates with wide ranging high/low bars. That intersection is the place that you have to expect buyers to come out in force if gold retreats. That is the demand side of the equation.

chart

On the supply side, you have to look to the weekly chart and the intermediate term time frame.

In this chart, there happens to be further confirmation that the demand zone described above is also reinforced on the weekly chart as a result of the intersection of the two high volume and wide price spread bars from February of 2012 where gold came crashing down for the third time over a period of six months.

chart

As for the supply side, neoclassical TA uses swing points in addition to wide price spread and high volume bars when mapping out supply and demand zones.

All are referred to as anchor bars and when combined they become anchor zones. The anchored resistance zone (supply) for $GOLD is the confluent price zone defined by the anchored swing point bars at the top of the November and February 2012 price peaks.

Note that volume on the latter is comparatively large when juxtaposed against what is being witnessed now.

Given the extension already witnessed over the past month in spot gold, a retrace right here and now wouldn't be earth shattering news. In fact, it would be expected given the 1:1 ABCD that has just completed as seen in the daily chart.

But before you start liquidating everything, realize that being extended isn't a good reason to trade against the trend. In fact, I cannot find any reason to trade against this trend when approaching it from a pure reward-to-risk or probability-of-outcome reasoning.

If you are still holding gold or gold stocks, the best trade is no trade until the next test occurs. At best you might trim a little but for most investors, just simply sit tight and wait for the test — regardless of whether it is a test that involves higher or lower price.

If the first test engages anchored resistance at higher prices, then the odds are it will fail on the first attempt given the extent of the run in such a short period coupled with inferior volume characteristics that will likely exist on the test. That would be an opportunity to take some profits and wait to reload in a larger way on the expected retrace. Notice I didn't say to short it though!

If, on the other hand, a retrace to anchored support comes first then that too will reveal information. There are two clear areas of support as shown on the chart with the higher zone being likely to contain sellers. What you should always look for is whether the selling pressure (supply) increases or decreases as prices move lower.

If the latter, then adding to your positions makes sense. If the former, then the better bet is to be patient and let it test more or potentially fall farther before attempting to add again.

As you can see, neoclassical thought is about identifying those areas on the chart where supply and demand characteristics are evident and then examine how those areas are tested. That examination yields information that you can choose to make more informed decisions about what to do in your investing and trading endeavors. It isn't about guessing what might happen but examining what does happen. It is about trading off known information; not unknown.

Certainly we can speculate about what will or won't occur. There is nothing wrong with that, and my take is that gold and gold stocks will work higher from here over the intermediate term time frame. That is my bias. Like any bias, it can change if the conditions on the ground change.

In trading and investing, what is critical is to continually challenge the bias with real time evidence about what is happening to either validated or invalidate the ideas. That is true from both a fundamental and a technical view. In my world, both are about supply and demand and both show up on the charts!

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