The return of gold

Gold has arrived at an interesting juncture.

When I last covered it on 13 May I wondered if it was ready for a rally, after the rapid plunge down to the $1,320 level in mid-April. Naturally, that shook the confidence of many bulls.

The fall attracted an awful lot of new shorts, as revealed by the COT data, and sentiment became extremely bearish – as you would expect after such a large drop.

But the magnitude of the bearish sentiment took my breath away, considering just a few weeks ago the market was full of gold bulls. How fickle are traders these days!

It’s as if you are madly in love with someone one day, and because your beloved disappoints you in some way, you utterly reject them the next, forgetting how good it was for so long.

Yes, gold has been very good to many investors and traders for many years as it climbed its great bull market. But now, it is utterly rejected by those same bulls.

This is a significant change in attitude – and sets up the very real possibility of a very large corrective rally. Remember, markets exist to surprise the majority.

Waiting for the C wave

Back in my last post, I had a possible scenario mapped out:

Gold price spread betting chart

(Click on the chart for a larger version)

My best guess for the potential rally was this A-B-C formation.

So let’s see how this is panning out:

Gold price spread betting chart

(Click on the chart for a larger version)

This is the hourly chart as of this morning, and although my original B wave low was too early, I do have a valid B wave and a potential C wave in the making. To confirm this as a C wave, I would need to see a rally above the A wave high in the $1,480 area.

Later today the most recent COT data will be released, but here is last week’s data:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
Contracts of 100 Troy ounces Open interest: 446,087
Commitments
189,401 109,142 22,414 192,147 276,269 403,962 407,825 42,125 38,262
Changes from 14/5/13 (Change in open interest: 2,281)
2,840 5,947 -3,299 610 1,621 826 4,269 1,455 -1,988
Percent of open in terest for each category of traders
42.5 24.5 5.0 43.1 61.9 90.6 91.4 9.4 8.6
Number of traders in each category (Total traders: 327)
129 111 70 62 64 222 218

So, when gold was in relief rally mode, the hedge funds, who are primarily trend-followers, added to their bearish positions.

So now, the hedge funds are only 1.7:1 long. This is a massive reduction, as only recently, they were well over 3:1 long. And the small specs are even-Stephen. This, too, is noteworthy.

The latest COT report comes out later today and could reveal an even more balanced breakdown.

 

So what are the chances the rally will extend?

Here is the hourly chart showing the rally off the wave B low:

Gold price spread betting chart

(Click on the chart for a larger version)

The rally has been very choppy, as I expected, as the market has had a severe shock to the system and the few bulls see a buying opportunity, while many other bulls are nursing big losses and wish to escape with some dignity (and capital) intact and are exiting on rallies.

I have a very pretty tramline pair. And the market is travelling inside the channel. I have a prior pivot point (PPP) on the upper line and five touch points on the lower line. In gold, which is a choppy market, this is about as good as it gets for tramline analysis.

A break of the lower line would be a bearish sign, and would probably indicate that I would need to abandon my $1,500 target. But if the market continues upwards, my next target is at the upper tramline in the $1,440 area (pink zone).

Under this scenario, because there is overhead resistance from trading in the first half of May, I expect step-wise racheting progress in a two up and one down manner.

Under recent relationships between various markets, if stocks are about to tumble (see recent posts), then gold should benefit.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline trading
Advanced tramline trading
An introduction to Elliott wave theory
Advanced trading with Elliott waves
Trading with Fibonacci levels
Trading with ‘momentum’
Putting it all together

• Don’t miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I’ve written them, just sign up here . If you have any queries regarding MoneyWeek Trader, please contact us here.