How Overextended is Gold?

I have been going over the market for gold ($GOLD) in class since last week. We have looked at daily and weekly data, viewed the RSI, and we have gone back to consider where the US Dollar ($USD) is, as the dollar and commodities are inversely related (other things being equal). What I want to do in this post is to show you another way to show whether something is overbought or oversold.

First, chart  $GOLD using daily data. Find a moving average that fits the time period under consideration very well. After a number of different values (starting from 20-day to higher periods), I found that the 150-day simple moving average fits gold very well, as the chart shows (click to enlarge).

To find a way to view how far the closing price is from this moving average, under "Indicators" below the graph, use the following information with StockCharts.com: MACD with values 1,150,1 (select MACD then enter the values I indicated).

That produces the graph below the Gold chart. You can annotate any (or all) of this set of charts. Here, apply a horizontal line to the peaks of the gap measure (the MACD values) to find where resistance has been before. It should be clear from the chart that recently, Gold price moved above its 150-day moving average by the greatest amount since either June of 2008 or September of this year. Note, also, this has occurred as Gold is very overbought based on the RSI (which is also showing a bearish divergence).So, you can see from this chart that there is yet another basis to conclude that some short-term pullback in Gold price is likely. Note, though, that markets can remain overbought for some time, so any pullback might not occur for a while yet.

Which Way Will the Market Go?

The recent rally has taken a pause at best, and perhaps the recent rally has run its course. While the market has declined for the past two days, today's decline was much larger than Monday, as the S&P fell by almost 20 points back to 815.6. How can we gauge whether this is the end of a rally or merely a pause in an uptrend?

Technical indicators are helpful for this. The following chart (click to enlarge) is the daily S&P performance over the past six months. There are two conflicting signals in this chart. First, note the performance of the RSI. While the S&P has recently risen sharply, that momentum was not confirmed by the RSI (see the lines in the chart). Recall, this is a bearish divergence. But if we work with moving averages, we get a buy signal. In the chart I have added the 20-day and 50-day moving averages. Notice that in the past few days, the 20-day has crossed above the 50-day moving average. This could potentially be considered a buy signal (recall: this is related to the average-marginal relationship we discussed earlier in the semester).

So, which indicator should we rely on? Since moving averages are lagging indicators and a bearish divergence of the RSI is a leading indicator, I would tend to go with the RSI's "signal." But that is still no guarantee that the rally is over -- it merely indicates a short-term pullback is in store which we are now witnessing.

In a situation such as this, you should look at weekly data for whatever information it contains, since weekly data does not contain as much "noise" as does daily price data. The chart below shows weekly S&P data (click to enlarge). I have added the 13-week moving average since this corresponds to a quarter. Note how well this fits the price data.

The weekly RSI shows very different momentum information than does the daily chart. Note the weekly RSI is far from overbought, and there is no bearish divergence. Actually, the RSI has failed for some time to move beyond 50, which would have indicated movement to more bull-market-type momentum.

In this situation, I recommend that you view an RSI value of 50 as resistance for the S&P's price movement. So, based on the weekly RSI, this rally failed at (RSI) resistance. I would only place bets on upward continuation when (and if) the RSI is able to sustain a break above 50. Were this to happen, daily data would clearly have to show an end to the recent pullback.

British Pound Nearing Record

The dollar has weakened against several major currencies over the past week. One of the most important currencies the dollar has depreciated against is the British pound ($XBP). The US dollar - pound exchange rate is now approaching $2. Using technical analysis, is there any basis to conclude that the current high values will continue to move higher?

First, it is important to establish whether the value the pound is approaching, $2, is a resistance level. To do this, remember the basic rule: Look left. What I have done is to extend as far back as far as my subscription allows (to the late 1980s). When going this far back, it is necessary to use monthly data so the graph doesn't get very messy.

When doing this, first, clear off the moving averages that are on the StockCharts.com graphs (the 50 and 200 period). Experiment with values and find a period that fits the most recent upsurge very well. In the present context, the 48-month moving average does this, as the graph shows (click to enlarge).

Examination of the graph shows that $2/pound is a very long-term resistance level that dates all the way back to the early 1990s. So, I have drawn a horizontal line to designate this fact. Support is the 48-month Moving Average.

Is it likely that the pound will break above its long-term resistance? The answer is yes, in the near-term, though. Note that the RSI is not yet at or above the overbought reading of 70 yet, so this indicates there is more upside possible. Also, below the main graph I have added a graph that shows how far the actual values of the pound are from the 48-month Moving Average. Apparently, 20 is the resistance level for that divergence (note: this is 20 cents). At present, the divergence graph below is not yet at 20, so this also appears to confirm that there might be further upside for the pound.

Remember, this is a likely outcome, not guaranteed. And, if the pound does move beyond its long-term resistance at $2, it will become overbought fairly quickly thereafter, as the RSI is very close to 70. So, whether a move above $2 can be sustained after it occurs is open to question.

As I have stated in earlier posts, use economics to determine whether the move after $2 (if it does occur is up or down). To do this, you must essentially formulate a forecast of the pound. A key factor is US monetary policy. Also, will the European Central Bank raise rates for the Euro zone? If so, relative US interest rates will fall (as the Fed is on hold with rates for now), causing the pound to appreciate further. See if you can identify other factors that will determine likely future values of the pound.