Why there could be big trouble ahead for gold

One of the most important disciplines for a trader is to keep checking your personal views and assumptions against what the markets are actually doing.

I’m constantly doing this. Nothing is more dangerous than zigging when I should be zagging.

As a matter of fact, trading is not unlike the field of science. As the 19th century naturalist Alexander von Humboldt stated: “A new theory is first derided. Then it is said to be irrelevant. Finally it is accepted, but credited to the wrong person (who has usually stolen it from the originator)”.

At a major turning point in a market, first the new trend is derided, then it is said to be a just a “technical correction”, and then, when it is well underway, it is accepted by the majority – just in time for a major reversal!

How markets are driven by human nature

This cycle keeps repeating time after time.

Why? Because its driven by the constant of basic human nature, which explains the connection in these three stages (three being a number that is significant in the Fibonacci sequence, of course).

The part of human nature I’m talking about is the desire to avoid appearing foolish and wrong, especially in public. In the Orient, it is called ‘losing face’, and is so powerful it has been responsible for many a suicide. Luckily in the markets, all we lose is money – and face.

But as one wag said: “When a person’s career and salary depend on believing the improbable, it is very hard to get him to change his mind”. And that built-in tendency of institutional rigidity is the reason why Britain sold a major part of its gold reserves in 2002/2003 right at the lows, for example. 

As traders, we have the luxury of being unconstrained in our judgments. That’s because our success (or otherwise) depends only on us alone being able to outwit the markets, which means we are able to take advantage of the inherent structural weaknesses in the big markets.

So let’s get to gold.

In my last post about gold on 9 March, I stated that the short-term picture was a little bullish, while the longer-term one was bearish.

The market had made an A-B-C correction to the big move down off the 20 February high at $1,790, and this was the picture then:

Gold spread betting chart

(Click on the chart for a larger version)

The large potential positive momentum divergence (green arrow) was a possible launching pad for a more substantial rally. But with the main trend down, something had to give.

In fact, the bears won out – and the market moved down to below the C wave, which is what I was looking for. My protective stop just above the B wave high was not in danger, and I retained my short position.

But where to take profits?

This tramline showed me a great place to take profits

It is time to look for possible tramlines. And I have found a beaut:

Gold spread betting chart

(Click on the chart for a larger version)

It is the lower line, which touches those pretty touch-points as marked by red arrows. As the market was dropping yesterday towards the yellow arrow, it was fast approaching this line. 

That was my cue to take some profit off the table, since the line has represented solid support since 29 February.

That was a very satisfactory gain of well over $100 per oz, or £1,000 on a £1 spread bet.

OK, what now? The market is recovering off the lower tramline towards my not very impressive upper tramline. This may be a turning point for the rally, but I do not have total conviction.

Note from Wednesday’s post on the Dow that in recent days, gold and stocks have diverged. This is counter to the normal relationship that has prevailed for many months.

As I said then, something is amiss and I expect this discrepancy to be eliminated at some point.

Now many traders will be trying to figure out why gold fell hard at a time when stocks were rallying. For what it is worth, my view is that hedge funds – who are the largest gold futures traders – have become so in love with equities, they sold gold futures to invest the proceeds in stocks.

The implication is that if they were still in love with gold, they would borrow the funds to buy their stocks and keep their gold positions intact.

If I am correct, this is a major shift in sentiment. It spells trouble ahead for both markets.

• 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

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