What's Gold's Next Move: Correction or $1000?

Includes: GDX, GLD, IAU
by: Jason Hamlin

Gold had been ripe for the latest $100 advance for quite some time. But this near vertical price increase has many analysts calling gold overbought, and predicting a correction in the short-term. So the question on the minds of many gold investors is this: Is gold really overbought and needing a correction, or does this upleg have room to run and a likely target of $1,000 by year’s end?

The commercial short position is at an extreme level and this historically precludes a drop in the price of gold. Many analysts also believe that the dollar is oversold, and are anticipating a rally in the coming weeks. Conventional wisdom supports the theory that nothing goes up (gold) or down (dollar) indefinitely, but are current conditions for gold really overbought and in need of correcting? Let’s take a look at the history of this gold bull, and see what the chart tells us.

As you can see from the chart above, gold’s last major upleg came after a 9-month consolidation period, and consisted of two huge (28%) spurts with a mini-consolidation in-between. In total, the last upleg increased $280 or 62% over the course of about 8 months.

The current upleg has similar characteristics including the fact that is was preceded by a 9-month consolidation and new lows for the dollar. However, the current run has only brought an increase of $100 or 15%. If the last gold upleg is an indication, the current upleg has plenty of room to run. In fact, gold would need to surpass $1,000 before any significant correction could be expected. The percentage price oscillator [PPO] also supports the view that gold has plenty of room to run before reaching historically overbought levels.

Even if we are due for a mini-consolidation as occurred last time, it would not be expected to last more than 2 months, and fluctuate 5% in either direction throughout the consolidation period. But before this would occur, gold can be expected to climb towards the $825-$850 range. The consolidation would then be followed by a quick resumption of the bull’s charge to the $1,000 mark. Some have speculated that we are already in the midst of this mini-consolidation, as gold has been bouncing between $750 and $770 for the past two weeks, but we think it is too soon to call.

While the massive spec long position/commercial short position is worthy of concern, it is also worthwhile to point out that these exact conditions were the precursor to the last major upleg in the gold market. Commercial shorts have the deep pockets that typically allow them to get their way, but they were forced to cover back in September of 2005, and we expect they will need to start covering in this scenario as well. The weight of the sinking dollar and magnitude of investment dollars flowing into commodities may be too much for them to overcome. The covering of these short positions could very well be the fuel that helps propel gold to new highs in the coming months. We will be keeping a close eye on the unwinding, and take it as a sign to increase our positions.