This gold price rally is finished

Goldman Sachs, the world’s most prestigious investment bank, has made its mind up about gold.

Goldman analysts think gold is heading below $1,000 per oz. And back in November, when gold was heading for $1,150 per oz, there weren’t many who disagreed with Goldman’s analysis.

And as I mentioned in my post of the 10 December, that was a classic set-up for a contrarian trade. Betting against the crowd would have racked you up $100 in gains so far.

If you’ve been following MoneyWeek Trader, you know that I like to trade on the opposite side of the crowd. That’s usually where the money is.

But betting against the crowd isn’t the only way to do it. Trading with the herd can be profitable, if you can get on board early enough (when there is no herd to join, ironically).

As the trend develops, the herd swells in size until it reaches a ‘sweet spot’ (you’ll know you’ve hit the sweet spot when the trend is consistently going in the same direction every day).

It’s at about that point that the investment trend has gone mainstream. And that’s when it’s time for you to get out!

Are we at that point with gold? It has been rising consistently since November. So is it worth taking profits here, and waiting for another opportunity?

A healthy rally dies

I last wrote about gold on the 14 January, when gold was trading around $1,230. At the time I drew attention to the lop-sided ratio of bears to bulls, which meant that the market was vulnerable to a classic ‘short squeeze’.

(A reminder: A short squeeze happens when the price of an asset starts to rise. When that happens, traders holding short positions begin suffering losses. As they abandon their short positions, they become buyers, and so the price of the asset rises even faster.)

So how have things turned out? Well, it looks like a few short sellers got burned last week.

This is what a short squeeze looks like

Gold price spread betting chart

Naturally, pundits have noted gold’s spectacular climb off November’s lows. All of a sudden, many have turned from bearish to bullish. But exactly how bullish are they? How committed are they to this gold rally? If I can get a handle on that, I may be able to locate a short-term top where I can take profits.

One of my favourite sources of sentiment readings is to scan seekingalpha.com articles. Seeking Alpha allows large numbers of investors to post their analysis, unfiltered. So it’s a good measure of ordinary investors’ sentiment.

Here is the full list of titles from Wednesday when gold was hitting $1,300: 

• Gold is making encouraging moves, time to invest?

• Will gold’s spectacular rally continue?

• Gold does seem to suggest a different degree of at least uncertainty

• Gold surges to 5-month high just shy of $1,300

• A mine as a terrible thing to waste

• Gold and silver: truly precious so far in 2015 – more gains ahead

So there you have it – from that small sample, I get a 0% bearish reading.

What does the commitment of traders (COT) data have to say about it? Here is latest data (as of 13 January):

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
CONTRACTS OF 100 troy ounces Open interest: 402,108
Commitments
192,959 62,733 40,729 129,436 267,112 363,124 370,574 38,984 31,534
Changes from 01/06/15 (Change in open interest: 8,087)
5,254 -2,794 -170 -991 14,013 4,093 11,049 3,994 -2,962
Percent of open interest for each category of traders
48.0 15.6 10.1 32.2 66.4 90.3 92.2 9.7 7.8
Number of traders in each category (Total traders: 291)
130 76 73 51 61 214 185

 

The numbers in the red box show even more longs and less shorts that week, which is just what we’d expect as a bull run gathers momentum.

Conclusion: this rally is done

So what’s my take? This rally is strong but it’s starting to look vulnerable to a pull-back. There’s just too much consensus that gold is going to keep going up. It’s time to think about taking profits.

What do the charts say? After all, they are my final arbiter.

The following chart is complicated, because it shows two separate things.

The first thing the chart is telling me is that the current price – which is marked 3 or C on the chart – is the third leg of an A-B-C pattern. And, according to Elliott wave theory, the third leg of an A-B-C pattern normally means a change in the trend.

The second thing the chart reveals is that the current gold price is right at the 78% level. And according to Fibonacci theory, it looks likely that the rally should run out of steam around now.

Elliott wave and Fibonacci readings both point to a change in trend

Gold price spread betting chart

So what should you do? Well, this is the perfect setup to use my split-bet strategy. This means taking half of my profits now, and leaving the remainder open with a trailing stop (A trailing stop sets a floor below a stock price. If the price of the stock drops to your pre-determined floor level, you immediately cash out, limiting your losses.)

That means that if the rally continues, we still make money. If it ends, the trailing stop will protect us from big losses and we’ll already have banked some profit on the trade. Heads we win, tails we win!