The gold price is poised for a big rally

It’s a fact of life that not all trades go according to plan.

Having a method to tell you when to exit a strategy early in the game is absolutely essential. The earlier you can abandon a false setup, the smaller the loss you will take – and that is always and everywhere a good thing.

Remember, a trader’s first objective is not to lose money; if you do make losses, makes sure they’re as small as possible. That is why I devised the very simple 3% rule and break-even rule.

Many traders believe their only task is to guess which way the market will run. Not so. That helps, of course, but preservation of capital should be your top priority.

Let me illustrate this principle with gold. My last post on gold was on 13 February. I’ve left it that long for two main reasons: first, I’ve had plenty to say on currencies and stockmarkets, both of which had been following my roadmaps in fine style. Second, gold was going nowhere and was not obeying my original script.

This was the daily chart at 13 February showing my best-guess Elliott wave scenario: the market was rallying off the wave 5 low made in November in the $1,130 region. The form of the rally suggested to me either a large A-B-C (with the large A wave consisting of a smaller A-B-C in purple as marked), or a budding five up.

Gold price spread betting chart

Sentiment towards gold was running negative, I believed odds favoured the five up outcome and a rally back to the $1,300 area.

This was the hourly chart a few days previously:

Gold price spread betting chart

This is what I wrote at the time: “So the arrival at the $1,220 level is the moment of truth. Will gold continue its decline? If the $1,220 level holds, it strengthens my case that gold is about to rise in value”.

A long trade at the $1,220 level was certainly a legitimate one and could be protected with a close stop. Unfortunately, the trade did not go as I’d hoped. 

My textbook trade went wrong, but my stops kept me ahead

The market did rally somewhat from the 12 February $1,220 entry, but the rally was clearly weak and had overlapping waves, which is normally a sign of a correction to the main trend. That was the first sign the trade could be in trouble: it was time to tighten stops.

Gold price spread betting chart

The rally was advanced enough by the following Monday to be able to draw in my wedge lines, so with the protective stop moved to just under the lower wedge line on Monday, the trade was stopped out (actually at a small profit).

The trend had obviously not turned, so I stopped looking for a long position until I saw better evidence.

Let’s fast forward to today. The question is: do I still believe a big rally is approaching?

Below is the daily chart with amended Elliott waves: it shows my best guess of the Elliott waves to date. Now, because of the extended decline off the January high at the $1,300 level, I have a better handle on that B wave – better than I had back in February.

Gold price spread betting chart

Because it has morphed into a five down (green lines) with a positive-momentum divergence, I can now make the case that gold is about ready to begin its large rally phase in the large C wave.

A look at that B wave on the hourly supports my theory. I have an excellent tramline pair with the upper tramline sporting two overshoots (not an unusual event in the gold charts). Last week, the market descended to the $1,150 level which touched tramline support.

Gold price spread betting chart

That was a possible long entry if wave 5 had indeed ended. Remember, fifth waves are ending waves. Also note the large positive-momentum divergence at the low – a sign that a turn is on the cards.

So, are we any closer to a rally today? 

Since 8 March, the market has been trading in the lovely mini-trading channel formed between the major lower tramline and the mini tramline (parallel) drawn across the recent highs (green line).

The green line on the chart below represents resistance.

Gold price spread betting chart

Overnight, the market has poked above this line, breaking the resistance.

Many shorts will have their protective buy stops lurking just above the recent highs (pink bars). Any move higher will touch these off like a Chinese firecracker and move the market smartly towards the upper tramline.

Remember, the market has been almost straight down off the January $1,300 high to the past week’s $1,150 low – a significant drop of $150. In that time, I expect bearish sentiment to have built up a head of steam – after all, the talk has been that gold would soon drop to below $1,000.

Stocks are the only game in town and deflation is now here, depressing gold’s allure as a traditional inflation hedge (though in reality it is nothing of the sort).

Here is the latest commitments of traders (COT) data, which is extremely revealing:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of 100 troy ounces) Open interest: 410,918
Commitments
171,821 89,929 43,257 154,578 243,920 369,656 377,106 41,262 33,812
Changes from 03/03/15 (Change in open interest: 5,794)
-8,740 25,188 -901 14,498 -19,547 4,857 4,740 937 1,054
Percent of open in terest for each category of traders
41.8 21.9 10.5 37.6 59.4 90.0 91.8 10.0 8.2
Number of traders in each category (Total traders: 307)
141 91 82 53 50 231 192

 

In the week 3 to 10 March, hedge funds (the non-commercials) reduced their long positions by 5%, but ramped up their shorts by a whopping 40%. I guess they couldn’t resist the siren call of the gurus with their persuasive sub-$1,000 targets.

Note that the commercials (smart money) did the reverse and took a large swing to the long side; they now hold a ratio of about 1.5 shorts to longs. Included are the gold mines who traditionally hedge (sell forward) their output and are almost always heavily net short the futures. This very moderate 1.5 to one ratio is actually a very bullish sign. A long trade on gold seems to be the smart move.

Stay tuned…