Three Indicators Point to Gold Being Ripe for Short-Term Correction

As I argued recently in The Must Know Truth About Gold, gold will be a long term buy as long as there is concern about the value of either of the most widely held currencies, the USD or EUR. All relevant government officials appear to be most cooperative for gold bulls, and have been willing to debase their currencies over the long term.

Still, nothing goes straight up forever, and there are 3 distinct technical signs that suggest a near term correction in gold's $1220 – 1190 range could be coming.

First, note 3 simple observations from the gold daily chart below (click to enlarge):

Gold Daily Chart Courtesy of AVAFX 28jun09

1. Beware the Bollinger Band (BB) Bounce

a) Most of the time, particularly since the start of 2010 (which has coincided fairly neatly with the blossoming of the European sovereign debt crisis from a potential problem into the primary threat to global markets), once gold pulls back off the top of its upper BB for 2 daily candles, it tends to test recent support.

b) Most of the time this test takes it to at least its 50 day moving average.

c) This has been especially true when the bounce occurs off of all time highs as seen in early 12/2009 and mid- 5/2010.

Beyond the above chart, consider the following:

2. The Gold/Oil Ratio Is Overextended

Historically, the ratio of unit gold to oil prices has been between 12:1 to 15:1. It is currently over 17:1. Granted, that could simply suggest the fear about the Euro (helps gold a lot) in the context of a bear market (hurts oil). Then again, historical ratios take these ‘exceptions’ into account and are a useful guide.

3. Gold Is Again Near Historical Highs

That alone suggests a tendency to test support, at least in the short term.

The Wildcard: Further Surprises To Inspire Fear About A Major Currency

As noted in The Must Know Truth About Gold, gold is neither a risk or safe-haven asset. It is a currency hedge. In good times it can rise on inflation fears, in bad times it can rise on fears of economic collapse or fears about damage to a specific currency. The more widely held that currency, the larger the pool of nervous investors, and the better for gold. There are plenty of potential sources for additional fear about currencies. The primary two are:

The European sovereign debt crisis – naturally: As noted in EU Debt Crisis For Dummies – May/June Update, there is plenty of potential for deterioration in Europe, both from the current players and other troubled economies that have as yet not hit crisis conditions.

The US Housing Crisis Part II: To be detailed in a separate article coming shortly, this is the biggest single threat to the US recovery because it threatens to further weaken both the US banking system and job market, (and thus spending too). Together these make up most of the primary manifestations of the US debt problem. This, by the way, is perhaps the EUR’s best hope for a quick reversal because it would refocus currency markets back on USD fundamental weaknesses, as was the case for most of 2009.

We like gold long term, but suspect it is overdone for the near term and better played as a short.

Disclosure: No Positions