Gold Breaks Out

Why is no one talking about the breakout in gold today?

After months of range-bound price action and diminishing trading volume, gold traded to a 3-month high, with the SPDR Gold Trust trading its highest volume since March. The breakout completes a classic cup-with-handle pattern, at both 3-year and 6-month scales. For the past few months, the price of gold has also been tracing a roughly symmetrical tightening triangle pattern, culminating in today’s bullish breakout.

On what is probably the most important trading day for gold over the past year and a half, today’s financial headlines are completely oblivious. The big news stories either ignore or gold and focus on the rather bland trading in the stock market, or if they mention gold at all it is in the context of the weaker dollar or “momentum buying.”

Of all days, Fitch even released a research report this afternoon suggesting that the short-term future of gold will be range-bound with a bias toward falling. Did they even check the price today?

Note the symmetrical triangle and breakout.

I imagine that some trading desks and enthusiasts are very excited about today’s move. If you examine a six-month chart or even a two-year chart, today’s breakout appears particularly bullish—and in some ways it is—but it pays to not get too carried away. Everybody knows that gold has posted significant returns over the past decade, and gold enthusiasts will tell you that there’s plenty more to come. And the fundamentals for gold support their case: the dollar is weak, the government is growing, markets are volatile, there is continued geopolitical stress around the world, and swine flu is just the most recent looming threat to our health. One source even reported yesterday on the accelerating accumulation of gold by the world’s central banks.

All of this—combined with today’s bullish breakout—points to a new massive bull run in the price of gold. The only weakness in the case is the long-term technical analysis. Since 2001, gold has experienced three major upward thrusts. In so doing it completed a classical Elliott Wave pattern. In a sufficiently liquid investment instrument, Elliott Wave theory suggests that three consecutive bullish waves are almost inevitably followed by a major correction (which gold experience last year, falling from almost $1000 per ounce to just above $700).

Note the 3 bullish waves (2001-04, 2005-06, 2007-08).

Since it is occurring at the top of the Elliott Wave cycle without a sufficiently linked the intervening correction period, the cup-with-handle pattern traced by gold’s correction and quick recovery over the past year is a “late stage base.” Late stage bases, as Bill O’Neil points out, are prone to a high rate of failure. Failure in this case would mean that the bullish breakout is short-lived and smaller than expected.

Based on these and other considerations, including comparison to similar patterns elsewhere, I believe it is reasonable to predict that, from today’s close of $978.50, gold will reach $1250 or perhaps $1300 before the end of the year (and silver may climb to $23). My analysis indicates that this price will be a long-term top to the bull market in gold, after which (one model indicates) the price may decline as much as 50% by the end of 2010.