As most people  know, gold has been in a raging bull market for more than 10 years rallying from about $250 per ounce to more than$1,250 per ounce. Many people are now wondering if the world’s currencies have any value at all and are flocking to gold as the only hard asset that historically has always had value.

Gold coin purchases are at an all time high. There are people walking up and down city streets and in shopping mall, holding signs saying “We Buy Gold.” There are even vending machines where  people can purchase gold bars. Of course, there are the ubiquitous commercials on TV about gold.

Does a contrarian look at all these factors and take the other side? Possibly, but the problem is most of these factors have been present for more than two years and gold has rallied more than $400. Why would gold be any different now?

I believe the psychology of the gold market is in a dangerous place, but manias can go on longer than people think. This happened in the real estate market in 2005 when everyone rushed in. Real estate TV commercials ran nonstop, many were buying second homes as an investment with no down payment, bankers were giving loans to anyone.

It took about three years for it to finally come apart. The gold and real estate markets are not related, but the mass psychology is eerily similar.

Are we finally at that tipping point? I believe we are.

Until two weeks ago, gold had been in a steady uptrend since February.  It was going up because of inflation or deflation; it was going up because Euro weakness or Euro strength or it was going up because of stock market strength or stock market weakness. People on CNBC have even said gold will never go down.

But close inspection of the gold market at this time show many technical difficulties that may bring it down. Below is a candlestick weekly chart of the gold market.

Source: Barcharts.com

Gold set the all time high of $1,264.80 per ounce during the week of 6/21/10, but that week also formed a candle stick called a “hang man”. This is when a market breaks off the highs but then runs all the way back up to the previous daily or weekly close. The next bar is critical because it must run back down and close under that previous low.  As you can see, this is exactly what happened.

The chart below also shows some import reversal patterns. This is a daily candlestick of gold. On June 21, gold made an all time high but closed below the previous day’s low. This previous day was the all time high. This can bea very bearish sign. Also notice it happened againjust five days later.

Source: Barcharts.com

There have also been some major divergences recently. The Gold Bugs Index bug index (HUI), a basket of un-hedged gold stocks, topped out in March  2008 just as gold did. From there, both markets had severe sell-offs. Since then, gold has come back to make new highs in November 2009, and then another rally to an all-time new high again in June.As you can see, HUI has not confirmed this high, not just once but three times. This triple divergence is also very dangerous.

Source: Barcharts.com

Source: Barcharts.com

The last component I analyze closely is the Commitment of Traders Report (COT).  The rally in gold this year has gone to new highs but buying from managed futures traders (the purple line) has not had the buying enthusiasm that accompanies these type of rallies. The large spec (the green line) also has been a reluctant buyer. The commercial trader (the red line) set an all-time record on the short side in March. This type of selling from commercials does not pinpoint tops, but it does put you on alert for possible market failures.

Source: Barcharts.com

Calling tops in a raging bull market can be very difficult and painful,but with so many yellow flags, there seems to be a great trade from the short side. If gold closes below $1,170 per ounce I think the gold market is in for a large fall.

Bruce Gwyn 
Managing Partner
Level III Trading 

web: http://www.level3trading.com
email: bgwyn@level3trading.com