Commentary for March 7, 2008

| March 7, 2008

As you know, divergences between technical indicators and price action are very important developments when it comes to technical analysis. A divergence, simply stated, is when two sets of data that would under normal circumstances be in agreement start to disagree to a certain extent. Over the years, we have watched for divergences between our Gold Currency Index (GCI) and the price of gold in US dollar terms, as they have nearly always provided advanced warning of an impending development. Of course, that is not to imply that a divergence always leads to significant move, but they tend to be predictive, so we watch for them with great interest.

At the moment, we are seeing a slight negative divergence between the GCI and the price of gold in US dollar terms. Let’s compare the daily charts of the two. First, we have the gold chart:

After the recent breakout from the pennant formation in the middle of February, price action has moved up to almost $1,000. Momentum moved up to levels just below the previous high of the short-term top in January, MACD histograms moved well into positive territory and remain well above the 0 level, and RSI moved well into overbought territory before dipping below the overbought level recently. Now, let’s compare this behavior with that of the GCI:

Price action also moved to new all-time highs after the corresponding breakout from an ascending triangle formation, but notice the difference in the technical indicators. Momentum has not come close to those recent highs in January, MACD histograms have already moved back into negative territory, and RSI barely managed to move back into overbought territory before returning to the middle of positive territory. Thus, the technical health of the GCI chart is meaningfully weaker than that of gold at the moment.

As always, technical analysis offers no guarantees. It is simply a tool that enables us to make reasoned judgments about where price action may move next. A divergence such as this is a signal that the trend has become vulnerable to weakness, so caution is warranted. We will continue to monitor this divergence carefully and see how it develops moving forward.

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Category: Commentary, Market Update


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