A Beautiful (Inverse) Head and Shoulders

Like many readers of Screwtape Files, I do some of my best thinking in the bath. Yesterday, whilst taking an especially long set of ablutions and trying to shake out the last few drops of shampoo from the bottle into my little furry palm, I suddenly had a εὕρηκα moment. The episode was fortunately captured for posterity by my man-servant, loyal old Mr Funkleberry-Hydesmuggler.

Please now steel yourself for some blue-eyed lemur semi-nudity...

(Artwork courtesy of Warren James, Screwtape Files 2012)

You see, I'd been reflecting all day on my bold claim that gold and its miners could be about to take a great leap forward, given the RSI, Slow Stochastic, and rock-bottom sentiment. I'd nervously watched the HUI crash down to 462 (where I spent the last of GM's snuff money without his knowledge) before sitting back to watch it gallop back up to 476 [now 481 at the time of typing]. I was confident in my analysis, but something still niggled. What could be the technical justification for a sudden sharp move in gold, which has been staying stubbornly low? What chart formation could back up all this fancy stochastic/RSI stuff?

My 'Head and Shoulders' shampoo [Reader: "I didn't know you had dandruff, Jeanne."]  [Jeanne: "I don't - I have nits. What of it?"] set me thinking of something GM wrote a month ago:
...note that if gold drops say 5% from here [gold was at $1726 at the time of writing], that would begin the last part of a major inverse head and shoulders pattern (perhaps even more so in silver) that would probably get the technical funds going strong long.
Hmm, well, gold has certainly dropped since 19 February, when GM wrote this. Let's see: $1726 - 5% = $1640. Interesting. Would that be the same $1640 that has been serving so heroically as stubborn support recently? You know, I think it jolly well might be. I therefore present to you the most beautiful Inverse Head and Shoulders you're likely to see for a while:

For a basic introduction to the Inverse Head and Shoulders chart formations, please see here, here or here. Essentially, the formation consists of two peaks (or 'shoulders') separated by a trough (the 'head'). It follows a downtrend (usually a sharp one, as in this gold chart), and - if it is a true Inverse Head and Shoulders it will be followed by a move to retest the Neckline (at around $1800 on this chart). If it passes through the Neckline, then a strong bull move is in play, and will often continue for the same price difference as between the Head and the Neckline. In the gold chart, above, this price difference is around $250 - 275, which would mean the Inverse Head and Shoulders formation and its resulting breakout would perhaps complete at $2050 - 2075, before a likely new correction comes into play.

Now I've described this chart as a 'beautiful' IH&S because of its good symmetry. In practice, a 'perfect' IH&S is never achieved, as the markets obviously fluctuate away from the mean trend lines, and are influenced by events and fundamentals rather than pure buying and selling (based on sentiment alone). But our example here is striking for the relative evenness of its two shoulders, and - most importantly - the near symmetrical distance between each shoulder and the neckline. I've rarely seen such a good set up for an IH&S, I have to admit. Even when we get into the substructure, one sees parallels in both shoulders, with 1 corresponding well with 1' and 2 with 2'.

But it's not yet an IH&S. Not at all. Because we now need 3' to correspond with 3 (which could imply a retest of $1625, although 3' may just end up being a small version of 3, in which case no retest is necessary), and then that all important dash for the Neckline and (hopefully, for the bulls) beyond. And that's still quite a big "if". However, if we combine this lovely formation with the analysis from RSI, stochastics, sentiment, etc., then it does feel rather as if the stars are beginning to align.

This feels particularly convincing when one considers that there are more than a few IH&S kicking around at the moment. Let's take a look at a couple more:

So, it's all about the IH&Ss for commodity bulls at the moment. But let's go back to my εὕρηκα moment in the bath. I'd been holding the bottle upside down (i.e. inversed), trying to squeeze out the last little bit, having no shampoo money left after spending it all on miners yesterday. But as I put the (now empty) bottle back on the shelf, and saw it sitting there the right way up again, another thought struck me: what about a good old-fashioned Head and Shoulders?

The bears could conceivably argue that GM's predicted massive IH&S is in fact just two sets of a Head and Shoulders formation, with our substructure, 1', 2' and 3', making up the the two shoulders and the head, viz.:

This could portend a sharp drop to the downside. But it's an ugly formation - no poise, no style. The neckline is extremely slanted, and the two shoulders very uneven. And its equally disfigured twin H&S formation to the left of the chart seems an equally unlikely structure.

It was then that I had my final moment of bathroom inspiration, whilst looking in the mirror after gently drying myself off. I spoke softly the treasured words of Keats:
A thing of beauty is a joy forever: its loveliness increases; it will never pass into nothingness.
Switching my gaze from shampoo bottle, to mirror, to gold daily chart, I knew then that Keats had called this next gold move correctly, way back in 1818.


David Markle said...

Two more weeks and the remaining shoulder will be complete. consolidation in the 29-30 region. Drop below 29 and we head to 26. almost there.

Anonymous said...

Hi, David. Thanks for commenting. It looks like my $1625 thesis is playing out - but one never knows. You may be proved right yet, not least with OpEx next week, and the dreaded Monday down day.

From a technical point, two weeks (an extra eleven candlesticks from when you commented) sounds like a stretch. I just roughly counted 26 candlesticks on the daily for the left shoulder. The right shoulder already has 31. If this were to become 42, the 'beautiful symmetry' that I described would become rather a Plain Jane.

But time, and the market, will reveal all...


David Markle said...

I was looking at silver...boy the weekly gold chart looks even better than Silver!

I use weekly verses daily as it makes it easier to count :)

On Gold I see a retest/consolidation around 1600 or below. On the initial shoulder creation it took 7 weeks to get to the neck. We are at 5 weeks down from the neck on the other side. And the shoulder needs at least 10 days of consolidation on reduced volume from what I see on the chart.

..at the point of consolidation I would think volume would dry up...Using GLD the volume has been pretty consistent around 10 million shares traded per day. I would think volume would fall to half that. The reversal would come with heavy volume in excess of 3 times current volume.

Things to consider: Investment houses are cleaning up their quarter portfolio's and will not be making large investemtns precious metals until April at the earliest.

I would look for the news that brought Gold down from its Feb highs to continue. (EURO? Spain?)

Need something that allows the banks to invest in metals at a low price. Thus the shoulder "stalls" as the houses buy from the public while trashing precious metals... Maybe dipping below 1600? The other shoulder actually went all the way to 1530...That would scare the investor!

Needs to be blood on the street for a true bottom. Not pissed enough at the metals to call this the bottom.


Anonymous said...

David: Yes, sorry, I read your first comment a bit too quickly there and I then proceeded to argue the case for gold rather than silver!

To be honest, it's always very difficult to determine where exactly shoulders begin and end, and where the neckline really is. We can only ever have an approximation, as the counting of candlesticks is more subjective than it should be...

That said, you set out a very convincing case for a retest of 1600 in gold. You also make important points about volume: I didn't address this in my article (basically, I didn't want to complicate matters), but it's true that volume has to be right for the formation to be a true IH&S. The Stockcharts website gives a very good explanation of this.

I'm surprised that there are observers out there brave enough to say we've definitely hit the bottom, given OpEx next week, and (as you point out) the end-of-quarter portfolio management. (It's also the end of the tax year in the UK). But a bottom or not, I think the case for gold (and maybe silver) going forward from April looks exceptionally bullish short-term.