How Chartists use Trends to Outguess Gold

by Bruce Hager

Sitting in his trading room, Martin Armstrong peers into the world gold market through an oversized screen upon which a jagged line depicts the peaks and valleys of New York spot prices for the past 90 weeks. Based in Princeton, New Jersey, the trading room is far removed from the frenetic events that push and pull gold prices in New York, London and Hong Kong exchanges. But in a glance, the electronic chart tells Mr. Armstrong where gold is heading based on past market activity.

Mr. Armstrong is a chartist. He eschews the standard fundamental explanations of gold’s fluctuations, such as political upheaval and inflation, and depends on the clearer vision provided by hindsight. By plotting past gold prices on elaborate charts, Mr. Armstrong and his colleagues look at the historical peaks and valleys to help explain the present and forecast the future.

“It’s a road map,” said the 36-year-old bearded chairman of Princeton Economic Consultants, a consulting firm that serves clients ranging from South African gold mines to national governments. “You can’t judge where you’re going unless you know where you’ve been.”

Although the technique and accuracy of these forecasts draws mixed reactions from the people who rely upon them, chartists are a key source of intelligence used by most professional traders. “Charts are a necessary evil of the commodities markets, and there are certain long-term chart points that make sense,” said Fred Bogart, head of gold trading for Republic National Bank in New York..

Lately, chartists have been taking a cautious approach. Last Tuesday’s $8.60 Drop in New York spot gold prices caused gold to dip below $325 an ounce and sent many analysts back to ponder their charts for what to expect next. The consensus was that gold prices had suffered a “bullish failure” but still had support at $320 to $325 an ounce and could attempt another rally.

Still, it is clear that the price drop has tempered enthusiasm. Before last Tuesday’s drop, gold had been on an uptick. Prices had risen consistently since the first week in July from a low of $309 an ounce to penetrate the $340 level in August. In the chartists’ view, this helped complete what some in the industry call a “saucer.” Here, prices dip, stabilize and then rise again, creating a saucer-like pattern on the chart. For a chartist, that sets the stage for a sustained rally because gold prices have gone through a correction, found a major level of support and then have begun to climb back.

“This is a classic type of technical formation that predicts an eventual bull market,” says Steve Chronowitz, director of futures research at Smith Barney.

The price movement last Tuesday, however, broke the short-term pattern. Mr. Chronowitz is still “very” bullish. “If the market holds up at this support, it’s a very constructive action for technical reasons.”

However, Jack Schwager, director of futures treading at Paine Webber in New York, warns, “If you had a couple closes below 320 and if you don’t find support, you could have a free-fall situation.”

Mr. Armstrong agrees, although he targets current support at $312 based on spot prices. Should prices fail to find support around that level, he predicts prices could fall through the February 1985 low of $281 by November. The determining factor, he says, is not how shares jumps or falls in any one trading day, but rather that prices can reach a new level and sustain a stability for weeks and even months.

Even when prices briefly broke through $34 and had been accepted by most chartists as the barrier, he still wasn’t convinced bulls were chasing the bears.

For a firm that charges clients a whopping price an hour, that analysis contrasted sharply with other term bullish sentiment at the time. But when gold tumbled after Labor Day, his analysis proved that had been shaky territory.

“Most people got all excited about that,” Mr. Armstrong said, referring to the breakthrough at $34, “the high wasn’t sustained.”

To be sure, Mr. Armstrong’s analysis and the client fee are not based solely on charts. Princeton Economic Consultants, with branch offices in London and Geneva, tracks data on a myriad other commodities and foreign currencies using a combination of cyclical and technical analysis to forecast price trends. In fact, it was falling foreign currencies that initially tipped him off that gold was going to tumble.

But chartists emphasize that their current projections have nothing to do with the market’s current preoccupation with South Africa.

“It makes absolutely no sense to be a fundamentalist in gold,” asserts Mr. Schwager. “In a traditional commodity, there’s a rough supply-and-demand estimate, and in gold, people tend to equate that supply with gold production and gold demand with gold usage. But there can never, ever be a shortage of gold.”

Indeed, some technical analysts are so faithful to their charts that they will studiously avoid any fundamental input. When John Murphy was director of futures research at Merrill Lynch during the 1970s and early 1980s, he had a hard and fast rule that no analyst could go into the trading room, lest the objectivity be swayed by rumor. “I do my best work when I don’t go into the office,” says Mr. Murphy, who recently completed a book on technical analysis and now works as senior technical editor the the Commodities Research Bureau futures chart service..

Some wags suggest that chart analysis is economic shorthand for fundamentalists, and not all chartists and technical analysts are purists. Mr. Armstrong acknowledges that some long-term fundamentals cannot be ignored, and Mr. Schwager concedes the impact of “intangibles,” such as the psychology of the marketplace..

“If South African mines shut down, then people will want to hold their gold and prices will rise,” says Mr. Schwager.

What the market has to do and will do on a certain date is a major distinction, and few technical analysts are comfortable making predictions on a day-to-day basis. Gold’s abrupt moves proves the limitations of daily chart analysis and leave traders skeptical. Nowhere was that more evident than on last Tuesday. “By the charts, it was supposed to go up. It didn’t,” said Beny Peraino, a gold trader for Rudolf Wolf Futures Inc. in New York, who also follows the fundamentals.

Still, technical analysts argue that their charts are the best weapon for short swings versus fundamentals that do not change daily. A technical analyst can immediately notice when something has graphically gone wrong, such as a spot price that has broken through a resistance barrier one day, then fallen the next, evidencing technical weakness..

But the trick of peering precisely into the future still escapes them.

“One of the reasons we use previous peaks as a barometer of tends is because we don’t have future prices,” says Mr. Murphy. He added with a chuckle, “We’re working on a chart that will give us tomorrow’s prices, but we don’t have it yet.”