Wednesday, August 22, 2007

Intermarket Analysis of Gold Stocks

One of the advantages that comes with tinkering with charts for hours each day is that I occasionally stumble across something really interesting. Although I was somewhat hesitant to release this post, I have decided to anyway, as a token of my appreciation to the 1000th unique visitor to my site, and to those who have written comments on my blog.

This chart relies on some principles of intermarket analysis, and is related to another technique I wrote about here. What my technique does is divide the Dow Jones Industrial Average by the Dow Jones World Stock Index. So, what does that have to with gold?

This chart is related to Gold since it can detect movements of the US Dollar, and I'll explain how it does that now. When investors feel that the US Dollar is going to start falling, they will be more inclined to sell US Stocks, which are denominated in US Dollars, and reposition themselves in Foreign stocks, which are denominated in some other currency. The chart below is able to observe this process:

In the above chart, the green area represents the ratio, the middle area is a MACD Histogram of the ratio, and the CandleChart on the bottom is a chart of the USD Index. The way to utilize my chart is to look for MACD crossovers as buy or sell signals for the US Dollar.

What is amazing is that the MACD Histogram in the above chart is actually a leading indicator. Let's look at a MACD Histogram of the US Dollar itself, and you will see that when it crosses the zero line, it is usually too late.

The problem with the MACD Histogram above is that it is too slow. It is, like all technical indicators, a lagging indicator. It is using price A to help forecast price A, which can only go so far. This is why I feel the first chart is superior.

Naturally, since the US Dollar and Gold Stocks trend in the opposite directions, if we reverse the intermarket chart, we can use it to forecast movements in Gold Stocks:

So, just to recap what is going on here, in the above chart we are dividing foreign stocks by American stocks, so that when the green area is increasing, foreign stocks are doing better. When foreign stocks are doing better that means investors are hesitant to hold US Dollar denominated stocks in their portfolio, since they are anticipating a US Dollar correction. When the US Dollar corrects, gold rises, and gold stocks rise.

Buy and sell signals are generated when the MACD histogram crosses over, or when RSI is oversold/overbought. The last three overbought sell signals have worked extremely well.

Finally, you can try this link to build your own free charts. So, I hope this post makes sense to you, and thanks for visiting this site.

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