I have been wrong on gold (so far)

I have a confession: I have been totally wrong on gold in recent weeks. Since the October 19 high of $1,190, gold’s decline has been savage, with only six minor up days in the last 32 sessions (that has to be a record of sorts).

What has surprised me most was that the July plunge low at $1,070 was taken out with Friday’s low print of $1,052. I certainly did not expect that – but anything is possible in markets.

I fully expected that the very crowded short trade and my Elliott wave labels would provide the support necessary for the decline to be turned back before now. I got that call very wrong.

I read many pundits, especially on gold, which is the ultimate sentiment-driven market. In gold, fundamentals seem to have little influence on short-term moves (as in today’s stockmarkets, incidentally).

For a well-considered bearish view of someone who has called it correctly so far, I refer you to Doug Eberhardt’s recent article on Seeking Alpha.

Commercials and small speculators are heavily short gold

Many are calling this a currency market. In other words, the booming dollar (traditionally bearish for precious metals) is creating a converse effect when gold is priced in pounds (or euros). This is not true as a glance at the gold price chart in GBP would reveal – GBP and euro gold prices are sinking almost as fast as the dollar price. However, the yen gold price is amazingly holding around its all-time high!

Because this is a very crowded trade, I am keeping a beady eye on the weekly COT (commitments of traders) data every Friday. In the week when gold moved down from $1,090 to $1,065, money managers had swung to the short side by a whopping 20%. At the same time, the small speculators had placed so many additional short bets that they were in the highly unusual position of being net short:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of 100 troy ounces) Open interest: 656,475
Commitments
165,084 136,121 177,177 270,123 294,588 612,384 607,886 44,091 48,589
Changes from 11/10/15 (Change in open interest: 16,965)
-2,148 33,666 -3,744 23,406 -21,481 17,514 8,440 -549 8,525
Percent of open in terest for each category of traders
25.1 20.7 27.0 41.1 44.9 93.3 92.6 6.7 7.4
Number of traders in each category (Total traders: 372)
143 155 148 56 55 283 282

 

That means that in order to force the price down by a modest $25 in the week, the speculators needed to use extreme fire-power. And since last Tuesday – when the latest data were compiled – the market has dropped even further, no doubt encouraging the speculators to add even more to their short bets (while the smart-money commercials do the opposite).

Not only that, but the DSI (Daily Sentiment Index) has been running in single figures for some time, which is an extreme from where rallies have been mounted in the past.

To put this decline into perspective, here is a 20-year chart:

Bullion Vault gold chart

Last week’s low near the $1,050 level is a Fibonacci 50% retrace of the entire  2000 – 2011 bull market. And we know what that means – the market has now entered a potentially massive area of support.

I have valid Elliott wave labels drawn where the decline off the October 2011 all-time high can be counted as waves 1, 2 and 3 of a five down (it could also be just as well be counted as an A-B-C down to a very large wave A low leading to a large B wave up). But either interpretation leads to a similar conclusion: either a wave 4 up or a B wave up lies ahead.

There’s an ominous pattern in gold – and it’s shared by the FTSE

With sentiment measures lining up to support a forecast for a near-term major low, it is time to examine the charts. Below is the daily from 2013.

Large red wave 4 is highly complex and is open to a variety of Elliott wave interpretations. But the overall picture is quite clear: the July 2013 plunge low is wave 3, the October 2015 high is wave 4 and we are now in the final wave 5 down.

But the overall pattern being formed is a classic declining wedge. This is the same pattern that is forming in the EUR/USD hourly chart I showed on Friday. And with sentiment in the euro off-the-scale bearish (a mirror-image of that in gold), the stars seem to be lining up in both markets.

Gold price spread betting chart

Ominously, I am seeing several ending wedge patterns in some related markets. There’s a very powerful reversal pattern underway in the FTSE, composed of the characteristic five sub-waves. When the fifth sub-wave was put in, that was the signal to expect a reversal; the market breaking through the lower wedge line was the confirmation a big correction lay ahead. I have explained how I played that FTSE swing in recent posts:

FTSE 100 spread betting chart

In gold, a move down to the lower wedge line in the $1,000 region is certainly possible.

But when the market turns back up, the move should be historic as the massed ranks of shorts are squeezed – and this should occur at roughly the same time as a rally in the euro (see last Friday’s post).

And in December, both the US Federal Reserve are expected to start raising the Fed Funds rate and also the European Central Bank is expected to announce an increase in its quantitative easing (QE) and negative interest rate policy (Nirp) programme. Which means things should get very exciting before Christmas.

So let me play a little game of conjecture. If I look at the 20-year chart and the decline off the $1,911 October 2011 high is really a large A-B-C, this is a possible scenario I see:

Bullion Vault gold chart

To make this a valid count, wave 5 must start pretty soon. The simple reason is that wave 3 is never the shortest wave of a motive five wave pattern. Wave 3 lasted about thirty months, so wave 5 must be shorter. If it gets going in the next month or so, wave 5 should terminate before mid-2018.

And how high could wave 5 reach? Of course, it would exceed the wave 3 high at $1,920. I have seen a few brave souls calling for $2,500 (although I do not know what methods they used). My feeling is that when the current deflationary period turns around, a tsunami of inflation will kick in (to exceed even that in the 1970s) and we may see gold exceed $3,000 and silver above its all-time high of $50.

Of course, this not my firm prediction – only one of several options.

In the meantime, though, the gold bulls are getting slaughtered as the great pendulum of sentiment swings massively in favour of the bears.