Thursday, July 01, 2010

Buy Gold Now or Wait for Pullback?

Gold Silver Bullion
With gold prices making new all-time highs, gold is getting lots of press. I’m frequently asked if people should be putting more gold into their portfolio.

I believe the answer is yes, but not yet.

Long term and from a fundamental perspective, it’s almost impossible to be anything but bullish on gold. With all the world’s central banks printing money as if it, well, grows on trees, the valuation of gold as a relatively scarce commodity has to go up. It’s only a matter of how long and how much.

In the shorter term and from the technical perspective, however, gold seems ripe for a pullback.

Most financial plans for overall portfolios would indicate that 5 – 10 percent of a person’s portfolio should be in gold or other hard assets. If you are building up to that level or have the belief that a higher percentage is right for you, then buying gold on pullbacks would be prudent.

Let’s take a look at why gold might be overextended in the short term.

Valuation in Terms Other Than Dollars

For many investors, valuing gold in dollars per ounce seems like a natural and universal way to look at the price of the precious metal. With currency fluctuations and other considerations, however, looking at gold in terms other than dollars can help us understand the value of gold relative to other investments. One of my favorite tools helps us see how many barrels of oil an ounce of gold will buy. We can see that ratio for the last eight years in the chart below.

Gold Weekly Chart
As you can see in the chart above, gold is the top line and crude oil is in the middle of the graph. The lower line is the ratio of the two, or the number of barrels one ounce of gold will buy.

Over the past two years, this ratio has been extremely volatile, traveling well outside of its historical norms. As the chart shows, the low end of the range over the past decade has been just below 5 barrels per ounce of gold. The ratio peaked at 18 barrels per ounce at the height of the real estate/credit contraction crisis.

With this ratio hovering around 16 barrels per ounce now, we can see that gold remains relatively overbought. While this is not a definitive analysis, it does point to a gold price that is historically stretched to the upside.

From a technical viewpoint, we can see that gold formed a price pattern related to a triple top in the past week.

Gold Daily Chart
The triple top is pretty easy to see. And the momentum indicators—Chaikin Oscillator (one of my very favorites), MACD and RSI—all show growing divergence with each new peak. The upward trend line is also being tested.

If the price breaks this trend line, gold will most likely test the February low down in the $1050 range. If that level holds, the intermediate outlook (the next 3 – 6 months) will look very bullish.

Adding gold to portfolios as either an inflation hedge or a crisis hedge is most likely prudent for many investors and traders. Making those purchases at more savvy market points will help you add at more reasonable prices than when the entire crowd is jumping on board.

By DR Barton of Van Tharp Institute

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