Where Next for Gold?

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Will gold get back to that all-time high?

So far in 2010, all eyes in the gold market have been looking up at $1,225, wondering whether gold will get back to that all-time high. Now that question has been answered, yet another arises—where next for gold?

Our answer is that this rally still has gas in the tank to run higher. Gold didn't break its resistance at $1,225 just to climb another $24 or 1.95% to $1,249. There must be more in this move.

kirtley gold

Considering the chart above, gold appears overbought and prime for a drop. The relative strength index is at 72.68 and above the 70 level, which would normally be a sell for us. Although we always load up heavily on gold when the RSI is on or below 30, we never sell when the RSI hits 70 during major rallies.

Why? Well, simply because when gold decides to go on a run, it generally disobeys the RSI overbought reading as it simply continues higher.

A textbook case of this is during that run to $1,225 in late 2009: the RSI was well above 70 in early November, while gold was just $1,100. Selling in early November because of the RSI reading would have made traders miss a whole $125 move upwards. And shorting the yellow metal at that time would've proved fatal. With this example fresh in our memories, we will not sell gold when the RSI gives us a sell signal during major rallies, and the current RSI reading of 72.68 does not deter us from being long on gold.

Prior to breaking the $1,033 major resistance with a follow-through to over $1,200, gold broke the $720 mark, which was previously another major resistance. From $720, gold subsequently rallied to $1,033—a move of over 40%. Gold made another 40% move when it surged through the $500 barrier to $720.

One may infer from these observations that we are likely to get another 40% move.

Considering the breakage of the $1,033 resistance area, this gives us a gold price for the present move of $1,446.20. This is a rough estimate, but it would not be unreasonable to expect gold prices to move up towards $1,400/ounce during this major rally. When one factors in the possibility that these moves could grow even larger than 40% as the gold bull market progresses and becomes more volatile, prices higher than $1,400 appear possible.

We normally look to the ultimate inverse gold price indicator, the U.S. dollar, for more clues on what gold prices might do and when. But because gold and the USD have recently been moving up together, this analysis technique isn't too helpful. However, investors should not lose faith in the gold bull market simply because this inverse relationship hasn't worked recently.

One should keep in mind that in the last gold bull market, gold and the U.S. dollar moved up together, so it is likely that this could happen again. Also, the fact that gold is rallying in spite of USD gains is a sign of great strength in the yellow metal.

We think that in the long term, as the USD resumes its bear market down trend, gold prices will continue to move higher. In the shorter term, we believe that if the Euro should find its footing and begin to rise as a result of perceived improvement in the sovereign debt issues in Europe, the USD will drop back slightly and gold price will likely take a hit. For now, gold has become a safe haven investment sparked by unstable conditions in Europe.

An improvement in European debt conditions would likely take away some of the premium presently given to gold. However, if this should occur, we expect only a temporary decline in the gold price, as USD weakness will ultimately drive gold prices higher. This could essentially work out as a win-win situation for gold, albeit with the second win scenario of EURO improvement slightly delaying gold's rise.

The bottom line is that the major rally, beginning with the breakout above the previous all-time high of $1033, is not over yet. We will likely see $1,300 plus very soon. And, we believe that gold did not recently break above its December 2009 high of $1,225 just to rally to $1,249. There is more to come!

As we are now trading at all-time highs, we are in unchartered waters. Volatility should be expected, and in large doses. In the short term, gold could drop back to $1,185. Ideally, however, we would like prices to consolidate at these current levels so that $1,225 will become a support level and a base for the next move up.

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Sam Kirtley
SKOptionsTrading.com

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