Some Annotations On The Gold Market
Dan NorciniI have received more than a few emails of late asking why I have been so relatively quiet in regards to my writings. The short answer is that I, like many others in the gold community, have been patiently waiting for gold to give some sort of evidence that its corrective action was finished and that it was through going down In the meantime, a trader has to make a living and thus other markets proved to be more interesting and offer better opportunity for profits.
In my opinion, the signals point to gold's time being at hand once again. I have several reasons for stating so and will list them one by one and let the reader judge for his or herself. Please keep in mind that I am a trader and thus look for a preponderance of weight to favor a trade before committing 100% to it. The past week or so there have been indications that gold was base building and laying a floor for the next leg upward but it was a bit too premature for all but the most nimble traders to commit in a big way to this market as it does have a nasty habit of shaking would-be bulls and kicking them around a bit before settling down and behaving properly.
For starters, let's begin with the actual price action of gold vis-à-vis the dollar. Those of you who closely follow the markets have no doubt noticed the keen correlation between the price of gold and the U.S. Dollar. Gold, being the anti-dollar (No - that is not the "antichrist" unless of course you happen to be a dyed-in-the-wool Keynesian), tends to move in the opposite direction as the main U.S. dollar trend.
As we all have seen of late, the Dollar managed to embark on what I personally believe was nothing more than a counter-trend, Fed-induced rally in a long term bear market. Some initial tough talk on interest rates by the Fed to save face, a few reports here and there suggesting the U.S. economy was still firing on all cylinders, a stagnant European Union economy and a domestic-demand lacking Japan, all contributed to an initial panic among dollar shorts which quickly turned into a momentum generated rush into dollars at the expense of the major currencies. Gold, of course, got bopped and down she went as the trading funds dumped their longs and began moving to the short side (note well - the short side of gold is the moral equivalent of the "Dark Side" - no doubt the gold cartel was heard saying to the funds; "You should not have come back Obi-Wan").
Regardless, beginning in mid March, August gold dropped from $452 to near $416 as the dollar commenced a rally from just above the 81 level to its recent high above 88. However, a funny thing happened on the way to the forum. After the "NO" vote on the European Constitution by both the French and the Dutch, the euro sank in an initial knee jerk reaction while the dollar popped up; however, gold, refused to give up much ground, and more or less proved cork-like as it would not stay down - the near tic by tic symbiosis between it and the dollar appeared to have been altered. That was the first clue.
Secondly, I would like to call your attention to the Commitment of Traders report detailing the makeup of market participants in the Dollar. A couple of weeks ago I had pointed this out on Jim's web site (www.jsmineset.com) that the dollar rally appeared to be getting long in the tooth and losing momentum. Additionally, market psychology around the dollar has undergone a HUGE change in a matter of six weeks in which we witnessed speculators go from overwhelmingly bearish to overwhelmingly bullish. I pointed out at that time that the net spec long position in the dollar was as big as any time we had seen going back to more than four years. The most current COT report actually was even more revealing - judge for yourself from the chart below.
There are a couple of items worth mentioning in regards to this chart. Notice that both the trading funds and the little specs have managed to run swiftly over to the long side and amass a very sizeable net long position. The funds especially covered their short positions and piled on a heap of longs in a two month period. Meanwhile, the commercial camp has a massive, and I do mean 'massive' amount of NET SHORT positions for this particular market (note - I am using the NYBOT contract -the actual forex market dwarfs that). The astute reader will notice that the last time the commercial category had anywhere near this magnitude of a position, it was a NET LONG one and that was in December 2004 when the dollar was flirting dangerously with the critical 80 level. Needless to say, the dollar has managed to run from that level to near 88 in 6 months time - a gain of some 10%. Could it be that the size of the commercial net short position is indicating that the dollar rally has run its course and is gasping its last breath before the terrible dollar fundamentals reassert themselves? This trader sure thinks so.
That is signal number one - gold is not going to continue much lower if the dollar is at or near its peak.
Signal number two is an internal indicator that I have developed for use with the gold market. That is the number of fund net longs as a percentage of the total open interest. Again, I have written on this previously so the reader can research that should he or she desire to do so.
In those previous essays that I have written, I have indicated that anytime the Fund Net Long % has dropped below the 15 level, the gold price has put in a bottom.
Keep in mind, I never use this "indicator" as a stand alone trading system or signal; it is merely one more thing that I look at when deciding whether or not to enter a market.
You will notice that as of last week's COT report, that number had breached the alert level that I have set up for use with gold contracts. While we could see it drop further as there is more room for further fund long liquidation and/or new fund short positions to be added, the move below this level has corresponded nicely in the past with bottoming action and thus is an important signal that a trader cannot ignore. The funds have plenty of room to move in and rebuild longs should they desire to do so.
Signal number two is thus given.
Again, at the risk of repetition, I mentioned previously that this signal is only valid as long as the gold market is in a LONGER TERM bullish trend. As to whether or not gold is in a long term bullish uptrend, one look at the next chart should suffice to establish that. Note that this is a weekly chart and is not filled with all manner of squiggles and such. It is very clean showing only a 100 Day Moving average and a long term uptrend channel. That is all that is necessary to establish the prevailing long term trend.
A simple glance confirms that there is not the least thing bearish about this weekly chart. The trend is steady and sustained in an upward direction, assertions of the Prechterites to the contrary. Gold would have to crash below the $374 level to signify a change in the long term trend.
Signal number three is a DAILY CHART of the August Gold contract below.
A brief explanation is in order. I have developed a proprietary indicator that I employ for use with gold which has served me quite well in the past after optimizing it for use with this particular market. I set up the indicator with varying inputs that allow me to take a long term, a medium term, and a shorter term view of the market. The strongest signals are generated when all three indicators cross up or down together within a certain time frame.
You will notice that the short term has already crossed over generating a buy signal; the medium term has also crossed generating a signal and the long term indicator, while not crossing up as of yet, has flattened and turned up indicating that the downward momentum is waning. Additionally, it is deeply in oversold territory for this particular market.
An aggressive trader will take the signal from the shortest term indicator with a stop out point below the recent low. A more conservative trader will wait for the medium term indicator to cross and then initiate his or her position, while the ultra conservative trader will wait for all three. He or she wants the trend to confirm itself before moving in although they are usually forced to put more money at risk since the stop out point is the same but from a higher entry level.
Regardless, two out three technical indicators have flashed a "BUY" signal and thus we now have three signals, all of them positive for gold.
One quick note folks - while I enjoy writing for the gold community and sharing some insights I have acquired over the years, please do not ask me what this indicator is or how I have developed it as I need to keep a few tricks of the trade to myself! I cannot give away the whole candy store if you know what I mean.
The last signal is a bit unconventional but is something that should be considered. It is a chart of gold as priced in Euros. You will notice that EuroGold is making a strong up-move and is closing in on some very important and critical resistance levels. I believe that any gold trader worth his or her salt should take this particular chart into account when approaching the gold market. The simple reason is that gold is an internationally traded metal and a goodly portion of demand for gold comes from outside our own nation. We cannot ignore therefore, the price chart that traders and investors from other countries are looking at when they are attempting to make an informed trading or investing decision.
There is no doubt in my mind that the recent turmoil surrounding the vote for the ratification of the European Constitution has exposed the weakness in the entire fiat money system that the would-be masters of the global economy have concocted going back to Bretton Woods in the 1940's. The Euro was supposed to be a viable dollar alternative for those nations and investors who were rightly troubled about the excesses in the U.S. economy and lack of fiscal discipline by its leaders. While I personally believe the Euro will survive this particular vote, confidence in the currency has taken a hit and one has to realize that uncertainty is always beneficial to gold as its age-old, historic role as the currency of last resort and the ultimate safe haven reasserts itself, naysayers be damned. The fact that the EuroGold price is rallying shows me that Europeans investors are moving some of their funds into the metal and not necessarily into the Dollar as would normally be expected with this sort of scenario unfolding.
I would add here that should the EuroGold price take out the E351 level in a convincing fashion, it would signify a profound change has taken place in Europe in regards to gold and would prove to be incredibly bullish for the metal's prospects in dollar terms as well in my opinion. That level is going to be a tough nut to crack however - that is why it is referred to as a "RESISTANCE" level - sellers are going to 'resist' its upward price movement at or near that level. Can the buyers overpower them and beat them back? We shall have to wait and see as this is only round one of what will be a multi-year contest but there is no doubt in my mind that this level will eventually give way as gold powers upward in this generational bull market.
A short reminder that markets can and often do surprise us and that is one of the reasons trading can be such a vexing profession. About the time one is assured that they have "figured it all out", the market will often do something completely and utterly baffling and bewildering to most experienced of traders. Good money management is essential if you are to survive and prosper while trading. There is no shame in being wrong on a market call - the shame is stubbornly refusing to recognize that the market itself is not validating your current view and it is wisdom to move out of the way until things clear up or you have the chance to re-evaluate your thinking. If you are convinced nothing has changed in regards to the fundamentals, then move out of the way while the technicals take over for a season and look to re-enter again when the timing is better and the market comes around to embracing your view. Do not attempt to stand there and put up a fight while each day you watch your trading account wither away. Not only will it lead to heartache and financial ruin but it will also rule out any chance you have of recovering your losses if you have no money left with which to play the game. Better to run away so that you may live to play another day that to die a hero's death on some hill of your own contrivance. Custer put up a helluva fight but never went home to his wife and family. Besides, the market will eventually react according to its true fundamentals and you will be well positioned to enter and not only regain your losses, but make a tidy sum to boot.
One final chart mainly for traders to reference in regards to August Gold. I have overlaid several layers of Fibonacci retracement levels taken from recent peaks in August Gold to give some indication of where resistance can be expected to develop. One of the ways to employ these numbers is to see where you get overlaps. Those areas in particular tend to be very reinforcing. You will notice the BLUE ELLIPSE which shows a convergence of both the 38.2% retracement level from the December 2004 peak and the 50% level from the mid-March peak which comes in near the $434.50 area basis August. I would expect some initial resistance to surface in this region. If gold can breach that level on a closing basis, then it has an excellent chance of testing the next level between $440-$442. A break of that will sent it up to near $450.
As usual, time will make all things clear.
June 8, 2005
Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at email@example.com with comments.
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