Written for Business Standard
January 11, 2012: Gold seems to forming a bullish  pattern after a brutal sell off last year increasing the possibility of a bullish reversal or at least a short term correction.

The bullish pattern -- inverse head and shoulders -- will take some more time to confirm and hence patience is in order. At the very least now is not the time to sell or short gold unless you are playing in the very short term. An inverse head and shoulder is a very powerful bullish pattern often leading to long term rallies. In fact the 2009 rally in the US equity index the S&P 500 began with an inverse head and shoulders. 

In a classic inverse head and shoulders pattern, price falls to a low (known as the left shoulder) and then rallies up. Then it makes a new low (knows as the head) and rallies to the level prices went to previously.The two high points of the rally are connected by a line (known as the neckline), which could be sloping up or down or just be straight.  In the next step prices fall again, but don't make a new low(known as the right shoulder) and rallies above the neckline. Once prices go above the neckline that's the signal to buy, if one goes by the text book.

A look at the gold chart (click here for Gold chart ) will show that prices have probably formed the left shoulder, head and neckline. Only if the right shoulder is formed and the neckline broken will the bullish inverse head and shoulders pattern be complete. The bullish pattern has the power to drive gold prices to at least $1750 and prices were at $1617 at the time of writing this article. Sometimes the bullish pattern is so powerful that it can result in a long term rally, which could take gold to new highs.

However, now is not the time to buy gold. We'd wait for prices to fall and form the right shoulder to buy or wait for a break of the neckline. If buying on a fall, one could take a position between $1565 and $1685.  

In fact the best price to buy gold was between $1480 and $1525 a few days back. The level is marked by two horizontal lines. That is where most professional investors buy as it was the level from where prices had a very strong rally. The strong rally was due to the fact that demand exceeded supply at that level. Notice that when prices came back to that level recently it shot up again showing there is plenty of demand left in the area. The fact that prices are making a bullish inverse head and shoulders pattern near that level should be good news for gold bugs.

On a fundamental level too there are factors to support a gold rally. First is the uncertainty in Europe, which has lead to a rally in the US Dollar. Both the US Dollar and Gold are considered safe havens, and gold could follow the rallying dollar. Secondly, there is some growth coming to the US. But remember that there is also a lot of liquidity overhang in the system due to the easy money policies of the US Federal Reserve Bank. Growth with liquidity overhangs stokes inflationary expectations, which is positive for gold.  

Additionally, gold had rallied too far too fast in the early part of 2011 and a correction was inevitable. Given the price action now it's possible that the corrective phase is over. However, one must keep in mind that nothing is guaranteed in the market and chart patterns can fail.