Guest Post: Has Gold Unwound its Overbought Status?

Submitted by Chris Capre of Second Skies LLC

Has Gold Unwound its Overbought Status?

One of the biggest questions being written about which is on traders and analysts minds is whether Gold has moved into bubble territory and is about to start a major reversal, or is going to keep on truckin’ Blind Boy Fuller style.  While my fundamental hat suggests it’s likely to continue its trend (as a hedge against bad govt’s), being a quantitative price action and ichimoku trader, I have to see what the technical picture is communicating.

For looking at whether a market is in an extreme phase and is set to reverse, we often look towards our weekly 20EMA spread.  This model plots the distance from the weekly closing price to the 20EMA as a gauge of market extremes or whether the trend is likely to continue.  If a market is at an extreme level, it usually has a very large spread from the 20EMA.  Any abnormal spread from the 20EMA is likely to return to the 20EMA.

Looking at the chart below, you are seeing the weekly chart on Gold over the last 6 years.  In this chart, you can see price’s movement and its relationship to the 20EMA, along with the lower indicator/model representing the spread between the week’s closing price and the 20EMA. 

We have highlighted the key peaks which generally occurred around a 1258 reading, or price having $125.8 price spread from the weekly closing price to the 20EMA.  This generally led to a pullback minimally to the 20EMA within an average of 4 weeks and a maximum of 10.  We would like to note that historically, since April of 2005, Gold has spent only 43 weeks below the 20EMA (closing basis) out of 541 for a total of 8% of the time, statistically displaying its tendency to trend upward.  It also means should Gold break below the 20EMA, the chances of price staying below it for extended periods of time are unlikely.

What we do have to note is the most recent parabolic run away from the 20EMA created an abnormal spike never before seen in history with a reading of 2718 or price closing $271.8 away from the 20EMA.  So the next logical question becomes what do we make of this and is it the end of this massive uptrend?

Our view is this is unlikely, considering the historical relationship to the 20EMA as noted before (8% of time below).   In fact, we may consider a pullback to the 20EMA to be a healthy thing as it will put Gold through a re-distribution phase and allow the order flows behind it to start another run higher. 

But, the extreme nature of this suggests price is likely to pullback to the 20ema within the next 2mos or by year end.  Across most instruments, price rarely has this kind of extreme or unstable relationship to the 20EMA and usually means the orders behind such movements have to normalize a bit before starting another run.  Keep in mind, this does not have to happen with a violent sell-off and could be the result of price hanging around the $1700-$1900 range while the 20EMA catches up to current price levels.

In fact, to add any new positions, we’d rather wait to let the spread normalize and move back into the prior range which suggested a very healthy trend. 

We also do have to add to the bullish prospects how price had one of its biggest weekly drops from an open of $1860.92, to an all-time high of $1911.89, then shedding $209 to the weekly $1702 low to do what??? Bounce strongly and end the week at $1827.  This is highly suggestive of how the buyers were ready to stand up to one of the most violent and largest % based weekly sell-offs and send the metal within roughly $40 or 2% of where it opened the week.

Thus, although the short-term price structure may suggest consolidation or mild pullback to the 20EMA, our medium and long term technical view is still strongly bullish.