Last week I showed that the S&P 500 had formed a fully developed head and shoulders pattern with the price index poised to penetrate the neckline. The neckline was penetrated this week, thereby executing the pattern. Our expectation at this point is that the decline will continue, and that the minimum downside target (emphasize “minimum”) will be about 810. (The minimum downside target is assumed to be equal to the distance between the top of the head and the neckline.) While the bearish case seems strongest at this point, a bullish outcome is not impossible. Bullish forces have weakened, but it is not at all clear that the bear market has resumed. A more positive analysis of the situation could be that there has been a two-month rally from the March lows, followed by a two-month correction/consolidation. The neckline violation could be the end of the correction and a bear trap. I present this outcome because I have seen it happen before, and it is not yet out of reach; however, I don’t think it is likely.
This week gold made a new low relative to its July top, and it has clearly broken down through the rising trend line drawn from the November low. The next is support at about 870, and there is major support at about 700. On Friday the 20-EMA crossed down through the 50-EMA, which generates a sell or neutral signal using the Trend Model. Since the 50-EMA is still above the 200-EMA (meaning that gold is still in a long-term bull market), a neutral signal has been generated for gold. Looking at the weekly and monthly charts, I am inclined to believe that gold has put in a longer-term top, meaning that I think the 700 level will be tested eventually. My guess is sometime early next year.
Bottom Line: The S&P 500 head and shoulders neckline has been penetrated, and a decline to at least 810 is projected. Gold has also broken support of an important rising trend line and appears to be making an important top.
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