HardAssetsInvestor

Written by Brad Zigler  |

June 28, 2009

The Gold Market’s Tech Clues

Details

Gold is a tremendously psychological investment. Technical analysis is all about modeling behavior. A match made in heaven?

• Recent signals
• The fundamental vs. technical debate
• The special case for gold

 

The age-old contrast between fundamental and technical analysis was highlighted last week when a reader of a Hard Assets Investor (HardAssetsInvestor.com) interview commented, "I love how commodities investors are focusing on the fundamentals, while people who are currently overweight equities can't shut up about the technicals."

Fundamental analysis uses economic, political and environmental data to forecast future price movements, while technically derived predictions rely upon price patterns and changes in market volume. Commodity traders often use "the technicals" as well as fundamentals when making market decisions.

It should come as no surprise, then, that HAI articles cite metrics from both disciplines to present a broader perspective on a market's potential for consolidation or breakthrough.

The price charts that accompany many of our articles often include some of these technical indicators. Take, for example, the chart for August gold below (current as of June 22), showing three technical indicators: MACD, RSI and volume.

 

COMEX/NYMEX Gold (Aug. '09)

 

Just what are these indicators? What do they purport to show? And why should anyone pay attention to them anyway?

 

Relative Strength Index (RSI)

Let's first look at RSI, or the Relative Strength Index. RSI assesses the strength of a commodity's price trend by comparing the string of "up" closes to the number of "down" closes over a specific period. RSI values charted for HAI articles are based upon a 14-day history and range between 0 and 100.

On the chart, lines are drawn at the 20 and 80 RSI levels to indicate the thresholds where the market may be overbought (≥ 80) or oversold (≤ 20). A top is indicated when RSI peaks through the 80 level and arcs lower; similarly, a bottom is signaled by a trough under the 20 level.

The RSI for August gold charted above is 40.36, neither overbought nor oversold, but clearly trending downward from the early June peak near 80.

It's important to keep in mind that RSI vacillations aren't stand-alone indicators. Like lab tests ordered by your doctor, they can be used to confirm findings made elsewhere or point to areas for further investigation. RSI analysis provides only one indicator of topping or bottoming; further evidence can be found in a commodity's price history and/or other technical indicators.

That said, technically oriented traders look for the same type of patterns in the RSI chart as they see in the daily price bar chart - head-and-shoulder formations, double/triple tops and bottoms, pennants and flags, etc. Often, these patterns are more obvious on the RSI chart than in the bar chart of prices.

Divergences between movements in the price chart and the RSI arc are typically taken as strong indications of market turning points. The end of an uptrend, for example, may be signaled when new highs are scored on the bar chart, but not on the RSI scale.