While the idea of technical price analysis may sound complicated for the everyday investor, market technician J.C. Parets points out that most investors are already doing it by simply studying market behavior and the price action of any asset. Parets, a money manager and founder of All Star Charts, is a Chartered Market Technician and member of the Market Technicians Association. HAI Managing Editor Drew Voros recently spoke with Parets about technical price analysis and how it can be applied to assets like gold.
Hard Assets Investor: What advice would you give an investor who’s interested in technical analysis?
J.C. Parets: I don’t really get too complicated. I’m more of a “keep it simple, stupid,” kind of guy. From what I’ve noticed, a lot of these very successful technicians really have been on the more simple side, really just analyzing price. A lot of people are conducting technical analysis without realizing that’s exactly what they're doing. It’s just trying to analyze price action and the behavior of the markets.
When you're talking about certain correlations—when the dollar goes up or down, how that affects commodity prices, how interest rates affect bonds, all of that—we’re looking at the behavior of the market. That’s technical analysis.
HAI: You’ve written recently about false price breakdowns in gold and how that can lead to fast moves in the opposite direction, as you like to say. How do you identify them?
Parets: The first and most important thing is to find a trend. One of the reasons that 2011 was difficult for stock traders was the lack of trends. We were down some, we were up some. But we were just in a sideways market. That makes it real difficult. But there were trends in other asset classes like gold. It’s been in a long-term bull market since the turn of the century, not just on an absolute basis, but on a relative basis as well, which I think is even more important, relative to stocks.
Back in 1980, the ratio of the Dow Jones industrial average to gold was 1-to-1. Over the next 20 years, that ratio went from 1-to-1, to 42-to-1. In other words, in 1980, one share of the Dow bought you one ounce of gold. In 2000, one share of the Dow bought you 42 ounces of gold. That’s the bubble that popped at the turn of the century. You don’t hear a lot of people talking about it. Ever since then, that stocks-vs.-gold ratio has been declining; 20-to-1, 10-to-1. Earlier this year we got below 6-to-1. Right now, if I’m doing the math correctly, the ratio is probably somewhere around 7- or 7.5-to-1.
But that trend is still down. Historically, gold doesn’t make top until that ratio is somewhere between 1–to-1 or 2-to-1. We still have a long way to go. We know the trend is there, not just on an absolute basis. We know gold is making higher highs, but on a relative basis, compared to stocks as well. Where do you get involved?
Let’s use gold as an example. Stocks can temporarily make new lows and quickly recover. A lot of times that might happen in a slow week. And, in this case with gold, that’s exactly what happened in between Christmas and New Year’s Day. Gold made new lows. And, sure enough, it quickly recovered and came back. Thursday [Dec. 29] was a key reversal day. It followed through a little bit on a slow Friday [Dec. 30]. And then, sure enough, we come back to work on Tuesday morning [Jan. 3], and we are a gap higher in gold.
We need a little bit more confirmation for the upside before we buy any more or pile it into the trade. But, when you see that, it represents a good risk reward, which, at the end of the day, is all we really care about.
HAI: Is there any kind of percentage move associated with a false price breakdown?
Parets: It’s tough to put a measured move on something like that. You could look at former levels of resistance or support as potential price targets. But it’s not like a fixed pattern, like a head-and-shoulders pattern, where you could come up with a potential downside move or upside move if it’s an inverse, or double-top or double-bottom.
From false moves come fast moves, for a lot of reasons. Sometimes people initiate short positions on that new low. So when gold goes back above that key support that was broken, the only way to unwind that short trade is to buy gold back. That creates momentum. Not only do you have the natural buyers, but you also have the short-sellers who need to buy it back. That false move has created this really fast move in the opposite direction. We see it all the time.
HAI: For it to be a false move, does it have to return above the low that was broken?
Parets: Exactly. The low in gold on Dec. 15 was $1562. On Dec. 28, that low was penetrated on a closing basis, which had a lot of people saying, “That’s my confirmation to sell it.” Some people say, “OK, let’s wait another day for another close.” Well, sure enough, the following day it closed below that level again.
And then Friday [Dec. 30], gold rallied. Come the beginning of the year, gold moved higher and continued to rally. Now gold is bumping up against that 200-day moving average, which is another whole story in itself. But if we can penetrate that 200-day moving average, you're looking at potentially another move, maybe to $1700 or $1800, which represents a great risk vs. reward.
It’s not about always being right. It’s not about your ego here. It’s just about, “What am I willing to risk for this potential trade?” And, if you're wrong, it’s not the end of the world. But if you're right, it’s a great entry point on a long-term underlying trend that we know is there.
HAI: So when investors are trying to unwind their positions, does it become a self-fulfilling prophecy?
Parets: It’s not a self-fulfilling prophecy by any means. Just because we see a potential false move—and, in this case, it’s worked out well so far—gold can just as easily roll over, make new lows below $1560-$1550, and we were wrong. There's nothing wrong with that. But, if we’re right, it represents a very, very quick profit potential that you really wouldn’t be able to generate otherwise.
At the end of the day, the most important thing we want to look at is price. It’s the only thing that’s going to pay us. I’m not an oscillator junkie. I’m not one of the guys looking at 20 different indicators and when they all line up, it makes the perfect trade. But I do look at the Relative Strength Index [RSI]. When you have these sorts of false moves, momentum in RSI has already started to trend higher.
For example, when gold made these lows in mid-December, the RSI made a new low and became very oversold.
But, on the next low, which was the lower low at the end of the month and the move that we’re talking about, RSI never got oversold and actually was in the process of making a higher low. So you have a lower low in price and a higher low in the RSI. That’s what’s called a bullish divergence.
Not only do we have the potential for a false move, we also have a bullish divergence in the relative strength index, which really makes me more confident in the trade.
