Gold is at a critical juncture

 Feb. 12, 2013, 12:43 p.m. EST 

 http://www.marketwatch.com/story/gold-is-at-a-critical-juncture-2013-02-12?siteid=bigcharts&dist=bigcharts

By Nigam Arora

There is much debate about the effect of currency wars on gold and its future direction. Currently, the fundamentals of gold are muddled. On the one hand, central banks continue to print lots of money, and some believe currency wars are imminent. On the other hand, inflation is stable, and the metals are under the control of the momentum crowd, which represents weak hands. Under such circumstances, it makes sense to turn to the long-term technical analysis for gold for guidance.

A picture is worth a thousand words. The chart linked to below shows the long-term technical analysis of gold.

Please click here for the chart .

But before delving into the technical analysis, it is important to understand the background.

Currency skirmishes, not war

My subscribers often forward me investment-related emails that they receive from other outfits that they deem worthy of consideration. Lately, the subject of many such emails has been currency wars. The most commonly asked question is, "Why are you not recommending gold ETF SPDR Gold Shares GLD +0.12% and silver ETF iShares Silver Trust SLV +0.30% to protect us from the currency wars that are occurring?"

I have never been a forex daytrader, but relationships between currencies play a big role in our allocation models. We often take medium- and long-term positions in currencies as a means of diversification from stocks, bonds and commodities.

My answer to the question of currency wars has been consistent for the last two years. There are no currency wars, just currency skirmishes. My forecast has been that we will see skirmishes for the foreseeable future, but no currency wars.

G7 statement

Monday morning when the gold pit opened for futures trading in the United States, gold fell out of bed. There were reports that the selling was from European and Asian investors, but the data shows that such reports were clearly wrong. China was on a holiday due to the start of the Lunar New Year. Prior to the opening of pit trading in the United States, the London gold fix was much higher.

There is no denying that gold is a solid means of protection against the devaluation of fiat currencies. A fundamental issue gold faces is that QE3, when properly analyzed, was not supportive of gold. However, the momentum crowd rushed into gold without fully understanding QE3.

The momo crowd that bought gold on QE3 represents weak hands. These weak hands panic every time there is short-term adverse news. The news Monday morning was that G7 officials were considering issuing a statement that G7 nations were committed to market determined exchange rates and not using government policies to devalue currencies.

What do you expect governments to say?

Does any person with even a few working brain cells expect governments to say anything different? Currency devaluations are real. Gold is a natural protection. The obvious question is why I have not been recommending gold. Ever since recommending scaling back gold positions , I have not recommended a long-term investment in gold, but simply have given a number of short-term trading signals. The same is true for silver; after allocating 20% of assets to silver for a long-term investment at $17.73, silver was sold between $45-$50. Subsequently I have given only short-term trading signals on silver.

As I have written in this space, gold and silver have been under the control of the momo crowd. They have run gold and silver up much further than their fair value. The Quantitative Screen of the ZYX Change Method calculates the fair value of gold at $1250 to $1400 and silver at around $24.00.

Gold technicals

With the foregoing background, it will be easier to understand the technicals of gold shown on the chart.

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As the chart shows, gold has traced a symmetrical triangle pattern. Many adherents of traditional technical analysis believe that a symmetrical triangle is a continuation pattern. Since the long-term trend of gold is up, the symmetrical triangle implies a breakout on the upside and is thus a bullish pattern.

A symmetrical triangle is traced out when two conditions are met. First, neither bulls nor bears are in control. Second, both bulls and bears have lesser and lesser conviction in their position.

In my testing on data from recent years, a symmetrical triangle has often turned out to be a neutral pattern. Nonetheless, a symmetrical triangle offers valuable information. My testing does agree with traditional technical analysis in terms of what happens after the price breaks out of the triangle. More often than not, after some backing-and-filling, the price moves strongly in the direction of the breakout.

As of this writing, on the news of the potential currency-related statement from G7, gold was approaching the lower side of the symmetrical triangle. Any break will have to be confirmed by at least three successive closes below the lower side.

As the chart shows, beginning in late 2008, gold started a strong trend. It moved up in a smooth channel and respected the trendline on the bottom on pullbacks until about mid-2011. The background colors on the chart are composites of our short-term proprietary indicators; green is a plus, red is a negative and blue is neutral.

In mid-2011 gold started a parabolic move up. In our 30 years of experience in the markets, we have never seen a parabolic move that does not at least temporarily end in exhaustion. The parabolic move in gold was no exception. In September 2011, exhaustion set in.

Gold pulled back to relieve exhaustion. It fell through the upper band of the channel, attempted to break out of the upper band of the channel, but failed. The failure caused a move down to break the lower band of the channel followed by a move up that failed to reach the upper band of the channel. This failure discouraged the bulls and the resulting selling caused the strong healthy trendline that started in 2008, to be decisively broken. A subsequent rally attempt was weak, in that it could not even reach the previous trendline. This whole action is illustrated in an orange elliptical shape callout tagged “trendline is broken” on the chart.

The Technical Screen is one of the six screens of the ZYX Change Method that we use. Traditional technical analysis constitutes only one half of the Technical Screen and thus only 8% of the ZYX Change Method. The remaining one half of the Technical Screen consists of our proprietary indicators based on new concepts such as the Smart Money data based on the analysis of tick charts.

What is next?

The chart shows that if there is a decisive breakdown from the triangle the downside target is $1284. On the other hand, if there is a decisive breakout to the upside, the target is $2074. Gold is at a critical junction. It is worth noting that the miner ETFs Market Vectors Gold Miners (GDX) and Market Vectors Junior Gold Miners (GDXJ), as well as popular stocks such as Silver Wheaton (SLW), Newmont Mining (NEM), Hecla (HL), and Barrick Gold (ABX) are likely to follow the direction of gold.

It is best to think of gold and silver in different time frames. On Monday, The Arora Report downgraded gold and silver. Our current ratings in various time frames can be found here .