Is the gold market setting up for a big rally?

The gold market has been getting a very bad press lately. It seems that the bulls have decided that their dreams of $2,000, or $2,500, or $5,000 gold must be abandoned.

You might recall that this was the common belief pre-2011.

Now, pundits are falling over themselves projecting lower and lower prices, which is a complete reversal of that bullish scenario.

In September, Goldman Sachs famously hit the headlines with this projection:

“While we agree with the mid-cycle price somewhat around $1,200, we believe that at least near-term it can overshoot to the downside, which is why we have $1,050 as a target. It clearly could trade below $1,000.”

When I see such a widely-publicised forecast from a leading trader with specific targets – and they are a long distance from the current market – I sit up and pay attention.

Here is the daily chart:

Gold price spread betting chart

Where small traders should focus

It is undoubtedly true that gold is in a downtrend, with lower highs and lower lows. But along the way, there have been huge rallies. This is always a danger for anyone trading long-term.

The problem is that if trading short, you must be prepared to sit through painful counter-trend rallies. Not many small traders are able to do this. It is only the large traders, such as hedge funds, that are able to weather these storms.

Why is this? Simply because we are trading on margin with a relatively small account. And an adverse move of a few percent in the market could wipe us out. Also, not many of us are psychologically prepared for a large setback to our account balance.

It would take a very stoic trader to do this. And although this is an admirable trait in many areas of life, in trading it can lead to a certain stubbornness to accept losses. This approach would break one of the main tenets of trading – cut losses short and let profits run.

These are reasons why small traders should focus on swing trading, where we try to catch the short to medium term swings.

Signs of a major bottom

I’m sure you have gathered by now that with sentiment on gold bearish – the latest daily sentiment index (DSI) reading shows only 10% of traders are bullish – a decent rally is possible.

Also, blog comments on gold have gone very quiet as the bear market has progressed. Most of the gold bugs have gone into hibernation. This is another sign that we could be seeing a major bottom soon.

So let’s zoom in on the shorter-term chart:

Gold price spread betting chart

From the plunge low to $1,180 in late June, the market rallied a large A-B-C, and in Elliott wave theory, an A-B-C is counter-trend. This pattern confirmed the downtrend was intact.

This Elliott wave rule is one of the most useful for a swing trader. If you can spot a three-wave A-B-C pattern appearing in a defined trend, then you can have confidence that when the C wave completes, the main trend is very likely to resume.

This would offer a low-risk trade since stops can be close.

And there is no shortage of A-B-Cs in the markets!

Will there be a rally?

Since September – when Goldman made its infamous forecast – the market has indeed declined further.

But is it in a position to stage a decent $50 – $100 rally? That is the kind of move swing traders love!

Let’s zoom in even closer:

Gold price spread betting chart

I have drawn in my tramlines from the late October rally high. The market has hit my upper line in the last 24 hours and is currently bouncing off it as the resistance of the line kicks in.

Now, what is the outlook this morning?

Gold price spread betting chart

Here is the 15-minute chart with new tramlines drawn on the rally. They are not ideal because they have several pigtails. But this is typical for the spiky gold market.

The centre tramline has just been broken and if it is a genuine break – we must always be on guard for head fakes – then my downside target is the pink zone on the lower tramline.

That move would close the wide gap formed late Wednesday. Remember, gaps of this kind normally do get filled before moving higher.

If the market does move down to my lower tramline, then that would set up the possibility of a good bounce. By then, the bullish contingent should be even smaller than 10% – and the market could be sold out.

At this stage, the long-term down-sloping tramline still offers strong resistance, but if the market could break above that line, a sharp rally could be expected.

Why? Simply because there should be many protective buy-stops resting above this line that have been placed there by the large army of bears. Remember, 90% of traders are bears!

So these are the competing forces at work in gold as I see them this morning.

One very telling factor is the activities of the world’s central banks. They own around 20% of the known global gold stockpile and are major players.

Since the 2011 high, many have been buying in size, but according to reports, have lost around $500bn on their holdings. That’s the kind of loss I wouldn’t like to take!

In fact, central banks are notorious for being very poor traders (that is not their function, I admit). But when the banks are buying, give it to them!