About that Inverse Head and Shoulders Pattern in Gold

It keeps coming up in conversation so let's discuss:

First of all, whenever discussing Gold prices we need to keep in mind that the precious metal has been trending higher for over 12 years. This is the case both on an absolute basis as well as on a relative basis when compared to Stocks (See Historic Dow:Gold Ratio).

Most recently, Gold prices went up 180% from their 2008 lows up to last year's highs. The correction that began from that peak is now about 7 months old. We've seen these corrections before and in all likelihood we'll see them again in the future.

Here is the potential Inverse Head & Shoulders pattern that's getting everyone all worked up: The left shoulder in the Fall, Head around New Years and the right shoulder is currently under construction:

The potential Head of this continuation pattern actually bottomed out in late December finding support at a former key resistance level from 2011. That polarity came into play and a false breakdown around the Holidays created a nice 2-month squeeze. (Jeff Macke and I discussed this on Yahoo Breakout).

But here's the problem: Notice how I keep using the word Potential. This is because we won't know if this pattern is confirmed until price takes out the neckline. Unfortunately Gold prices are around $1,650 with the neckline up near $1,800. So it doesn't do us any good right now except for acknowledging that the possibility is there and recognizing the implications if the pattern is completed.

If this is indeed an inverse head & shoulders pattern, then you're looking at about a 250 point measured move from the neckline that would take Gold to about $2,050. The math is simple: Head to Neckline is about $250/oz ($1,800-$1,550). You take that number and add it to the neckline around $1,800 and that gives us the $2,050.

But all of this is meaningless until we see confirmation. Below is a near-term look at $GLD (SPDR Gold Trust Shares). The last week and half has been spent below upward-sloping 50 and 200 day moving averages. We have to give the benefit of the doubt to the bulls here for that simple reason alone. The presumption is that if the price of $GLD can get back above these moving averages, that increases the chances that the neckline gets taken out on the next test. But Gold still has some work to do:

New lows in Gold and $GLD here would almost certainly take prices down to last year's lows, but more importantly the moving averages would roll-over making this a bigger mess than it already is. That would signal to me that a lot more time is needed before Gold can go on and continue it's long-term uptrend.

So the bottom line is that we can acknowledge the possibility of the Inverse Head & Shoulders pattern. But we cannot on confirm that or really make a high conviction trade until we see more information. But with the long-term uptrend still intact, I think that the yellow metal is in the innocent 'til proven guilty category. Remember that anyone who has called a top in Gold prices over the past decade has been wrong. And I don't like shorting into a trend this strong. So we'll stick to the long side and pick our spots.

Tags: $GC_F $GLD $XAUUSD $IAU $GLL $DGP