A counter-trend rally could mean quick profits in gold

Gold has been in a downtrend for some time, but could a rally be about to catch traders unawares? John C Burford examines the charts.

It has been a while since I last covered gold and that was because most of the market action was concentrated in the stockmarkets. But today, it is gold's turn and I want to show several notable chart patterns.

In my last poston gold on 7 December, gold had just hit the $1,050 area, which I noted was an area of major long-term support, because it is at the Fibonacci 50% retrace of the bull run from the 'Brown low' in 2002 to the all-time high in 2011.

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Any time a market makes a Fibonacci 50% correction to a major wave, that is a notable event and cautions traders to expect at least a pause in the current trend. This guideline applies in all time scales and I use it constantly on my favourite short-term time scale, the hourly charts.

So what has been the market moves since then? This was my hourly chart posed in December:

15-12-7-MWT-3

I had a superb tramline pair working and the explosive rally in early December had hit my T3 target. That was an excellent place to take at least partial profits on trades taken on the upper tramline break.

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But in December, there was no follow-through and the market eased back to test the $1,050 low again.

That was the time to sit and wait for another clear signal. Sometimes, it pays to stand aside and observe.

But early this month, the market woke up and started to edge back up. Recall that in December, bullish sentiment was very low and that was one reason I expected a rally phase to begin at any time.

Here is the Commitments of traders (COT) data I showed in December:

Non-commercialCommercialTotalNon-reportable positions
longshortspreadslongshortlongshortlongshort
(Contracts of troy ounces)Open interest: 536,215
Commitments
160,479147,438118,844218,055225,105497,378491,38838,83744,828
Changes from 11/24/15 (Change in open interest: 806)
-1,6135,5902,2633,163-6,3703,8131,483-3,008-677
Percent of open in terest for each category of traders
29.927.522.240.742.092.891.67.28.4
Number of traders in each category (Total traders: 343)
1391341185354255250

Unusually, hedge funds (the non-commercials) were holding almost as many short futures as long, with the small speculators holding a plurality of shorts. This extreme bearishness led me to believe a sharp rally could not be far off.

So what is the position today? Here is the latest COT data:

Non-commercialCommercialTotalNon-reportable positions
longshortspreadslongshortlongshortlongshort
(Contracts of troy ounces)Open interest: 551,508
Commitments
160,944112,697143,482205,805253,064510,231509,24341,27742,265
Changes from 01/05/16 (Change in open interest: -1,139)
6,180-11,480-11,248-18823,250-5,2575224,117-1,662
Percent of open in terest for each category of traders
29.220.426.037.345.992.592.37.57.7
Number of traders in each category (Total traders: 361)
1621201275860273262

Now, the hedgies have switched to a more bullish stance. In fact last week, they moved sharply to the bull's camp with a move of over 10%.

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So did the price follow? Here is the latest hourly chart:

16-1-18-MWT-2

My December tramline (in pink) was genuine and that was demonstrated by the pull-back to the kiss on 17 December. That support held and the market moved up sharply from it in a classic scalded-cat bounce.

That was a signal the market wanted to move higher and a long trade was indicated.

But there was no sharp rally until the market started its move in the first week of January. It was then that I could draw in another tramline (blue). It has a nice prior pivot point (PPP) in early November and at least four accurate touch points. When the market broke above it in the first few days of this month, it was confirmed as a new line of support (it was resistance before the break).

And when the market pulled back last week, it planted another kiss and moved sharply up and away in another scalded-cat bounce. Isn't that pretty? This kind of action usually signals that a trend reversal is at hand.

Not only did the latest kiss mark a short term low at the $1,072 level, it was also an important Fibonacci support level:

16-1-18-MWT-3

Not only is the $1,072 level is where the market kisses the tramline support, but it is also at the Fibonacci 62% support level a powerful combination, and an ideal place to enter a low-risk trade.

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Of course, preparing your charts in this way with the Fibonacci levels and tramlines already marked out gives the nimble trader opportunities to enter orders (and protective stops) ahead of time.

This policy avoids the frustrating habit of the gold market to spike to your target and stay there for only a few moments before zooming away. If you are not at your screen then, you miss the best price and you necessarily must use a wider stop. This cancels out the advantage of your careful analysis!

With gold trading this morning at the $1,090 level $40 above the $1,050 low is it set for that explosive rally?

Here is the daily chart:

16-1-18-MWT-4

So far, the $1,050 level is holding and the waves up could be the start of a five up with the latest kiss on the $1,072 level my wave 2 low.

But to confirm, I need to see a move above the recent wave 1 high and that level at $1,112 is my key. If the market cannot move above that fairly soon, the downtrend should resume.

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Interestingly, stockmarkets are in rally mode this morning, and the relief rallies I have been expecting (see Friday's post) may be starting. I expect to cover them on Wednesday. Tune in then.

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