By Andrew Segal, Lind Plus Senior Market Strategist
There are a number of factors that influence the price of gold, but none more important than the value of the U.S. dollar. I think continued weakness in the dollar and technical chart formations have positioned gold for a potential breakout to the upside. December gold futures traded near $968 an ounce on August 6.
Gold Market Fundamentals
Much of the movement in the gold market is directly tied to movement in the U.S. dollar. To get a broad perspective on the value of the dollar, it is helpful to watch the ICE U.S. Dollar Index futures contract, which measures the performance of the U.S. dollar against a basket of currencies, specifically, the euro, Japanese yen, pound, Canadian dollar, Swedish krona and Swiss franc. The U.S. Dollar Index is currently at a four-month low near 78.00. I think this signals a growing concern of inflation among investors. 
Risk tolerance is definitely moving back into the market. During the market turmoil of last year (October, 2008) the U.S. dollar acted as a safe haven. But now that stocks have rebounded, risk aversion seems to be fading, and the risk appetite among investors is growing.
Here’s a quick summary of the fundamental factors influencing the gold market:
• Fresh lows in the U.S. Dollar Index.
• Slight reduction in Gold ETF interest as of late.
• Higher gold production from Sino Gold and Freeport.
• Bullish Commitment of Traders report.
• Announcements from the Bank of England and the European Central Bank
• Unemployment numbers (Friday, August 7)
Gold Market Technicals
A quick look at a gold chart shows a potentially very bullish formation. The formation of a symmetrical triangle (as seen in the weekly chart below) often indicates a continuation pattern.
Similar triangle formations appear on the daily and monthly charts of gold. Because of the bullish triangle pattern, I do favor a breakout in the gold market. Meanwhile, the Relative Strength Index (RSI) is near 51-52, which does not yet indicate any overbought or oversold conditions.
The changes in open interest are also important to watch. If you’re looking at a market from a technical perspective, you always want to make sure you look at the total open interest and the total volume, rather than just the open interest and volume in the front month. This is a good way to analyze the market and complement your charting.
You’ll notice that when the price moves up strongly in a market, the open interest rises in the direction of the move. The open interest tends to fall when a market pulls away from its highs. An analysis of the open interest and volume for the gold market shows that the bulls are clearly in control.
I would recommend buying gold anywhere below $940 an ounce. You can also position yourself in September or October bullish call spreads. These spreads can help you keep your costs down, while still allowing you to take advantage of breakouts. As with any trade, you want to have a profit objective, and proper risk management to protect yourself.
Silver Market Fundamentals
Silver has outperformed gold in the past year. It responds to much more than just the U.S. dollar. It’s important to remember that silver is primarily an industrial metal. Many people only view silver as a cheaper jewelry alternative to gold or simply as a precious metal, but silver has many industrial uses.
Other fundamental factors influencing silver include a decline in Mexican silver production during the month of May, and a bullish Commitment of Traders report.
Silver Market Technicals
I think the technicals on silver look even better than gold. There is a head-and-shoulders bottom forming on the daily December silver chart. This gives us our marching orders on how to trade this market. The pattern was activated with a breakout over $14.08 an ounce. Meanwhile, the RSI is neither overbought nor oversold.
You can see the left shoulder of the chart on June 18. It tapped a low of $13.64. The head at $12.47 was formed on July 13, and a pullback to the right shoulder came at $13.18. The really interesting thing on this chart is that the volume is ideal for this pattern. In a head-and-shoulders pattern, you want to see the volume decreasing as each of these lows are made. The left shoulder occurred on volume of 105,700, the head on 99,934, and the right shoulder 97,761. The open interest has also behaved nicely.
If you’re not long silver, I would suggest buying on a moderate pullback. In these types of pullbacks, we typically see a retest of the trendlines. I would recommend taking profits near $15.70, while also using stops to protect yourself.
This market is extremely bullish, but I wouldn’t be surprised if silver retested the neckline of the head-and-shoulders pattern. But there’s nothing to say that it has to. I would recommend getting long and adding positions if we’re fortunate enough to see the moderate pullback. I also would also recommend buying call spreads for September expiration. Because of the way silver works, I think the calls are slightly undervalued.
Andrew Segal is a Senior Market Strategist with Lind Plus. He can be reached at (800) 924-1060 or via email at asegal@lind-waldock.com.
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