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Gold Forming a Head and Shoulders Pattern

James Turk 4 May, 2009

Markets always require vigilance and patience, but sometimes they demand even more. They sometimes require extraordinary patience. We are at one of those moments in time with regard to gold and silver.

There is every reason to be bullish here about the prospects for both precious metals, both over the long-term and short-term. The purchasing power of national currencies in general and the US dollar in particular is being eroded as central banks pursue a zero interest rate policy and quantitative easing. These actions are inflationary, and consequently, the bull markets in gold and silver are alive and well. Importantly, I expect that we will soon see clear evidence to support this conclusion.

Spot Gold Price -4 May 09

Just how soon can be explained by the accompanying gold chart. I focused upon this chart in a commentary that I posted last week on the GoldMoney site. It can be read at the following link: GoldMoney.com

This chart takes a closer look at the “V” pattern that I have been highlighting in recent articles. These chart patterns provide important clues about the condition of the market, and typically denote a base or a consolidation within an uptrend, which is what the “V” is telling us here. But note the ‘head & shoulders’ pattern that has formed within the “V”. In short, what we have here is an extremely powerful technical formation that bodes well for gold’s upside potential, but here’s the important point with regard to timing.

Note the red downtrend line formed since the February 2009 high. Gold is on the verge of hurdling above that downtrend line. When it does, we can expect gold to rally to the neckline (the green horizontal line) at $1,000, completing this H&S pattern.

Once the neckline is reached, it would be normal to expect the H&S pattern to be completed. That would occur when the neckline is exceeded. In other words, the H&S pattern will be completed when gold exceeds $1,000.

In the for what it’s worth category, H&S patterns can be used to project near-term price objectives. The depth of the H&S pattern represented approximately a 30% correction (gold fell from $1000 to $700). Therefore, it would be normal for gold to exceed the neckline by 30%, which projects a $1,300 gold price when the neckline is eventually hurdled.

Note that I am saying when it is hurdled, rather than if it is hurdled. I think it the probabilities are that high for the H&S pattern to be completed, and for that reason, the normal outcome of these patterns can be expected – i.e., the breakout from the pattern will be approximately the same percent of the depth of the correction (as measured from the neckline to the top of the head – or the ‘bottom’ of the head in this case as it is a reverse H&S pattern). Only time of course will tell whether I am right. But I think we should be focusing on $1,300 gold as a near-term price objective.

There are of course other reasons to be bullish about the page-3 chart. Gold is still above its 200-day moving average. Also, gold tested and held well above support at $850, which marks underlying strength. The important point is that the gold chart in its entirety is extremely bullish.

So my recommendation is to watch the red downtrend line on the chart very carefully. A New York close for gold above the $914-$915 area should be enough to break the downtrend line. When it is finally exceeded, look for gold to rally back toward $1,000, and soon thereafter begin what I expect will be gold’s final assault on $1,000. Once gold hurdles above this level next time, it will not look back – just like the Dow Industrials never looked backed after hurdling 1000 in 1982.

James Turk

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