A Good Look At Gold
The study below originally appeared at Treasure Chests for the benefit of subscribers on Monday September 18, 2006. Please note the charts have updated for the benefit of all.
Overly optimistic and unprepared investors were provided with a reality check in the precious metal markets over the past couple of weeks. And still you hear them, talking about how 'the powers that be' are attacking gold right now in connection with upcoming mid-term elections in the States, along with the unsold allotment European bankers could be dumping on the market. After all, what else could be causing all that selling? It couldn't possibly have been a bunch of foaming at the mouth bulls all leveraged up on margin. Oh no. Or bottom of the barrel commodities houses leading Johnny come lately's down the garden path, a common occurrence in all bull markets at or about the a time a top of some significance is being traced out. Nah - not a chance.
Here, these types of investors are usually looking for the most popular game of the day, where they are ready and willing to jump on any bandwagon as long as it's going in the right direction. Do they care if all the fundamentals are in place for an extended run in gold or not? Answer: No. These types are momentum players, where it could be tulips they are investing in for all that matters as long as it's going in the right direction. Of course once the tide turns this means they are also eager sellers because again, predominantly they are just price follows, not fundamentally oriented investors who have actually done a little research into what they were putting their money into. Nope - not these guys.
This of course does not mean that officialdom won't give things a nudge in the desired direction when it suits them, as it seems we are hearing from some bureaucrat or central banker daily now. Make no mistake about it however; if market internals (primarily sentiment) are not conducive for the desired result, it won't happen. That's right, and you had better get this understanding straight, as it could impact the way you view risk and your portfolio moving forward. Just as the Feds cannot monetize all the markets (stock and bond) all the time as some would have you believe, they also cannot cause gold to fall out of bed just by starting a rumor European banks are selling a pile of gold into the end of September to meet their quota. Moreover, this is especially true when it's common knowledge they will likely miss their quota this year. Nope - it was the flaming bulls that did it to themselves this time, as always in full measure, where the market toppled over on it's own based on excessively bullish sentiment.
As seasoned investors, we of course welcome the appearance of volatility because it provides us with 'golden opportunities' to accumulate more of the metals at lower prices. Of course you have to be on the right side of the market to actually profit from such occurrences. And while we are not traders of our gold and silver bullion positions, as they are viewed as part of our core holdings, at the same time if you were planning on adding more, or trading futures, or trading liquid precious metals shares, I'm sure you will agree staying ahead of the curve is a very good idea. In this respect, let's review our comments on gold's prospects over the past few weeks, as follows:
• September 6: Regarding silver we said, "Mid-term elections are coming up and the economy is hurting. So, it makes a great deal of common sense to think central planners will endeavor to keep the population pliable in coming months, which normally involves a good dose of party favors. Of course what they might get is a good dose of reality instead, but for now, between domestically oriented liquidity related measures, along with what appears to be a continued desire on the part of hedge funds to play with leverage via the yen carry trade (at the center), one must assume pressure in the pipe will be maintained. This does not mean a good correction is still not in the cards however, where in spite of overwhelmingly bullish supply related fundamentals associated with silver, one more larger degree move lower appears necessary to complete what for all intents and purposes is actually a very bullish structure in the making for the long-term. (i.e. think descending and contracting triangle or rectangle.)"
• September 6: Regarding precious metals shares we said, "The bottom line for most investors here is to be careful on new investments into precious metals shares right now until the attached ratios above see breakouts in their indicators, allowing prices to run impulsively. This view is consistent with the knowledge an October / November interim bottom is possibly in the cards given this has been the pattern in previous years (2001 and 2002) that saw precious metals shares seasonally top in the proximity of May / June.
• September 7: Regarding gold we said," And to finish up today in terms of our bullets, as per the breakout in gold on Tuesday, and as pointed out yesterday, if gold cannot hold the breakout, which we will measure as a close below $630 spot today, this will usher in the risk of considerably lower prices. Weaker crude oil / commodities will have traders thinking pressure is coming out of the pipe, raising the specter of deflation. As discussed above however, lower equity prices will give the FED leave to become formally dovish, with the only question after that being whether market rates will follow. This is a time for caution from a trading / volatility related perspective.
• September 10: Regarding gold we said: "What's more, we will be back tomorrow morning with some thoughts on how sentiment is also primarily determining market direction in the precious metals sector right now. Therein, while it appears we were not completely out to lunch in talking about official efforts to knock the metals down on Friday when it became obvious something more than your garden variety pullback in an advance was not the proper context to categorize the noticeable drop seen last week, what became plainly evident to me on Friday after some investigation into the overly zealous market participants are paying for COMEX gold calls, is when you boil it down to which factor is for the most part driving this market, it's sentiment. Moreover, it's not just the high premiums investors are paying for calls, these same small speculators are back to near record high ratios calls to puts, meaning the break we saw in gold's point and figure chart triangle Friday is likely for real, even though it hasn't altered a bullish outcome as of yet. In order to do this, a quadruple bottom break of the descending and contracting triangle must occur. A close below Friday's lows will accomplish this task.
• September 11: Regarding gold we said, "In turning to technical considerations now, assuming prices are unable to recover overnight losses and close higher, which for reasons outlined above should be viewed as unlikely, gold will have broken significant Fibonacci (Fib) / structural / moving average supports, not too mention the large round number at $600, which should go a long way in waking up the overly enthusiastic in the crowd. Lest we forget, until these guys gain some respect for this market and / or are flushed out, prices will not turn around. And, given the technical damage currently being traced out in the trade, where for example an RSI diamond in gold's daily chart is being firmly penetrated to the downside today, even if sentiment were to do a complete about face over the next few days, which to an extent it will, it's going to take a while to get prices heading higher again in all likelihood.
Not to belabor the point we were quick to realize bullish sentiment was way out of whack in the gold market, the important thing for you to realize now is that gold and silver are a lot closer to being 'buys' than anything else already, and that these perspectives provided the other day in this respect are as good as any, as follows:
• September 12: Regarding gold we said, "As promised yesterday, here we are this morning to comment on a few of our precious metals stock selections. Before we do this however, I would just like to cover a bit more on gold. Firstly, and as per our Progressive Interval System (PI), gold has now broken below the large round number at $600, but has not closed greater than 3-percent ($582) below the measure for 3-days, so until a confirmed sell signal pointing to a progression to the next large round number at $500 is triggered, a reversal higher is possible at anytime. That being said, because the break yesterday at $600 was so violent (impulsive), in better days you would be compelled to think that after a test at $600 is complete, down the price should go. Today though, with the bipolar nature(s) of most traders, this is not necessarily the case. That is to say, yesterday gold was 'bad', and today gold could be 'good', so everybody might want back in. It's only when gold and silver represent 'wealth' to a larger audience will these games diminish."
• September 12: Regarding gold we said, "Moving a bit further down the rabbit hole now in this regard, upon a cursory check of sentiment in COMEX options yesterday, early in the session investors were still throwing money at contracts, paying up to 100-percent premiums to value in some cases, but by the end of the day this hysteria seemed to have faded. At this point then, while no firm conclusions can be drawn, we may be witnessing the first glimpse of sanity (respect for risk) returning to the market. Again though, even if this is the case, because a great deal of technical damage is being done right now, normally the gold market will not stabilize for some time. In this respect, as with precious metals stocks, we are still looking for a bottom in the October / November accumulation window found in seasonally bullish years. This allows for gold to fall further, where in addition to supports identified yesterday, you should know the measure off the structural break takes the price to $525, which at this point will serve as our maximum corrective target. Remember though, if you are in the market already, don't try to trade this move now as a very important low (Primary Degree B) is being put in here, where the bottom could just as easily be at the strong convergence of support identified at $575, only a few dollars away from current prices."
Fast forward to today, and we have a few updates pertaining to both sentiment and technical related considerations outlined above. And for organizational purposes, we will present this information in bullets as well, as follows:
• Utilizing key technical considerations to set the tone for a sentiment update, as always at such junctures, the most important observation of the day is to watch whether gold can close above $582, which is 3-percent below the large round number at $600, as per our PI. I see that in overnight price action it's trying to get over this hump, but so far has been repelled. What is so important about this observation is that it will tell us what gold intends to do on a larger scale if it closes below the mark for 3-days in a row. If it does this, a significant 'sell signal' will be triggered suggestive the next move of consequence will be down to the next large number of equal degree to $600, which is $500, usually after a brief relief rally to gain the energy to fuel the move. Here, we would expect gold to vex the $600 area again considering the nature of its short-term technical condition. (See Figure 1)
• Further to the above technical observations, and moving past the strong convergence (Fib / structural / moving average) of support at $575 denoted the other day, with gold now closing below the $582 mark for 2-days already, which is enough for most to consider a sell signal triggered, although we may be getting ahead of ourselves, it does appear likely gold is destined for lower trajectories given a totality of technical considerations, and in spite of the fact gold is now approaching oversold extremes on the daily, as seen above.
• As you can see however, and in spite of the fact significant technical damage will have already occurred, this should be viewed as a test of the trend, meaning far higher prices lie ahead, in that the way we are counting the move, Primary Wave B will be marked with whatever lows are seen. Further to this, and while the larger degree correction could be over within the confines of technical observations provided in the above figure, the bad news is if the May highs did indeed mark a Primary A top, then the retrace can go much deeper than what Figure 1 is allowing for. The good news is, because Intermediate Degree Wave 5 extended impulsively, the correction should not go more than 61.8-percent of this move, meaning in round numbers we are talking about maximum lows of approximately $535, as identified for you last week. Again however, if these lower reaches are exceeded, then Pandora's Box will have been opened in terms of possible Primary Wave B targets, where a trip below $500 is not out of the question. These possibilities are presented for you on the following weekly plot, where it should be noted if both channel support at $525 and the large round number at $500 go, then ultimate Fib related support identified in purple comes into play, which corresponds to a 61.8 retrace of the entire bull market, where from a structural perspective, such a move would be nothing more than a 'swing reaction' off channel failure in direct proportion to how far prices bubbled above that same channel. (See Figure 2)
Believe it or not, and not that it would make a difference in how most feel emotionally at the time, this would all be very normal not only from a technical perspective, but from sentiment related perspective as well, where without a doubt all the excessive bullishness seen in the sector of late would most assuredly have been driven out of the trade for a good long time. This would then set the stage for the next Primary Degree (big) advance.
Is there any precedent for this variety of price action in recent history to provide us with clues as to the most probable outcome given the possibilities outlined above? Well, in attempting to compare apples to apples, meaning a previous Primary Degree B Wave correction to the current one, we would of course have to travel all the way back to the 70's. As you may remember, these were volatile times in the securities markets, where prior to the bone crushing two year 61.8 retrace in gold experienced between '74 and '76, essentially cutting it in half on quick calculation (from $195 to $103), the Dow had just finished doing the same during the two preceding years. (See Figure 3)
Source: The Chart Store
Of course today with our fragile asset dependent economy(s) hanging in the balance, a very strong argument can be made such volatility could not be endured, and for this reason would not be allowed by the 'powers that be'. In the first place, and although without a doubt it's not difficult to observe they go to great lengths in influencing the markets today, as mentioned above, it should be understood authorities cannot monetize stock and bond markets as readily as many think (neo-cons), and that in fact it's all the negative bets (sentiment) set against adequate liquidity keeping stocks afloat in for all intents and purposes is a grand short squeeze.
Knowing this, and realizing some day this condition will be sure to exhaust itself, and that stocks are most likely to suffer a very significant (Grand Supercycle Degree) meltdown, for our purposes we would simply like to point out that if gold is in a strong bull market, like stocks have been in over the past twenty years, when primary channel support is reached, it generally doesn't pay not to also consider such an advent 'primary support', and buy the heck out of it. This certainly was what happened when the S&P 500 hit primary channel support back in 2002, and although you may not have known, prices are now vexing the channel's top, although based on technical observations provided below, it appears if sentiment towards future prospects were to ever turn bullish, or perhaps even just a little less bearish as measured by index related open interest put / call ratios, the result could be a toboggan ride down a steep slope. (See Figure 4)
This is all conjecture however, and not something one plans for through speculation, but through portfolio planning and risk management strategies of course. Additionally, this also does not mean keeping your 'eye on the ball' is not important, where we endeavor to do so as a matter of course in monitoring the health of all markets that concern us. Moreover, this is especially true in identifying high probability turn points which can prove quite rewarding through the full measure of time if you are a larger degree position trader, or looking to place some new money into gold. For example, if you are in that position now, today we could see a significant 'sell signal' triggered with a 3-day close below $582, which again, would be greater than 3-percent below the large round number at $600, and suggestive a test of the next interval of equal dimension at $500 is in the cards, as per Gann.
Of course what we know about channel support identified above suggests we should be buyers in the $525 - 535 area if this occurs, especially if near the end of November coincident to Fib / channel support readings hitting the tape. At the same time however, one should also not be surprised if this support doesn't hold in needing to go down and test larger degree Fib related support in the mid-400's, as per the 70's. Certainly a traditional 3-box point and figure chart reversal measure is suggestive of a deeper correction as being a distinct possibility, not to mention the appearance of what could be characterized as menacing stochastic influences pictured on the weekly plot above. Who knows, right?
Well, in putting this all together, and attempting to calibrate a likely target for a deeper correction based on a confluence of high probability targets married to harmonic patterns that have characterized previous impulses, if we compare the 500-percent initial Primary Degree move gold made in the 70's to the triple it just put in against a two-thirds retrace to what would be proportional today, not surprisingly 50-percent is the measure. In terms of the bull move thus far then, this brings us back into the $500 area as the most likely price target from this perspective, with the exact measure being $492, and potentially lasting in the neighborhood of a year and a half total in terms of a proportional time measure, as well. What's more, you can't help but like the logic associated with this target given 50-percent retracements have been a signatured feature of the entire move from 2001.
Knowing this, where it appears patience may prove a valuable commodity in short supply these days if more recent sentiment readings in the gold market are any indication, all we need to do now is wait and see if Mr. Market has this in mind as well. In this respect, some will say that in the full scheme of things it matters little whether one buys gold closer to current proximities, or whether the large round number at $500 will come into play. Of course it's always nice to know the probabilities associated with these possibilities when making such decisions, which we at Treasure Chests continue to monitor for our subscribers ongoing.
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Good investing all.