This piece expounds upon what we covered last week. In that piece, regarding gold, we concluded:
If gold is able to firm up here and then it has a good shot to rally back to $1,750-$1,800 over the next few months. If we get the bullish scenario and a fundamental catalyst shift then expect gold to break past $1,800 in Q3. That would mean that gold consolidated for two years which would be its longest consolidation on record. The longer the consolidation, the more explosive the breakout.
Following that editorial, we noted that various sentiment indicators continued to look favorable even as the market began to make some progress. For example, the daily sentiment index for gold touched 6% yet gold didn’t make a new low. At the same time we saw a continued reduction in speculative long positions. Bloomberg reported that hedge fund long positions in gold were reduced to the lowest level since August. Technically, take a look at the weekly chart. Gold seemed at risk below $1,630 yet it closed above $1,650 in each of the past four weeks. Now that gold is starting to turn bullish all time frames (daily, weekly, monthly) it has a great chance to rally back to $1,750-$1,800 over the next few months and position itself one step closer to a breakout.
With that said, we want to show why gold is setting itself up for an excellent breakout later this year. In the chart below we are focusing on two things: the price action and the volatility as measured by Bollinger band width (bottom rows). Have a look.
Thus far gold has experienced three major breakouts and four major consolidations. The type of breakout depends on the preceding consolidation pattern. The strongest breakouts are born out of consolidations which are tight in terms of price but long in terms of time. The 2004-2005 consolidation, which lasted 20 months, fits that profile. It had the strongest breakout of the three. Meanwhile, the other breakouts weren’t too shabby.
The current consolidation is most similar to the 2004-2005 consolidation. It is 17 months old and will last two years unless it can blast through $1,800 on the next try. Also, its tight range of $1,550 to $1,800 has remained in place. Furthermore, note the volatility on the various time frames (as measured by Bollinger band width). Two of the three readings are at eight-year lows while one is at a five-year low. The last time all readings were at multi-year lows was in 2005.
Gold does have potential measured targets of $2,050 and $2,250 but in our view those are only initial targets. A target of $2,250 is only a 25% advance. Even a 40% move (less than the first two breakouts) equates to $2,500. This sounds wildly bullish but the technical arguments are there and we are counting on another six to eight months of consolidation before the initial breakout. That consolidation will serve to eliminate any marginally weak hands and replace them with ardent bulls. After a two-year consolidation, those on board would be looking for far more than $2,000 or $2,200.
Before I close, I’d like to note that I will be presenting at the Vancouver Resource Investment Conference on Sunday, Jan. 20, at 4:30 p.m. at the Vancouver convention center west. This is a great opportunity to talk to analysts and companies face to face. This is a critical time in the precious metals sector. The market remains in consolidation mode and that will continue. Yet, the potential on the other side is vast. There is still time to uncover the stocks poised to be huge winners when and after gold makes its next breakout.