Elliott Wave Gold Update VII

June 18, 2006

Last week, if you felt like the person in the cartoon below, you were probably in good company. It was a gut-wrenching downward plunge that challenged the emotions. Relax, there is some good news.

There is also some bad news. The scenario outlined in Update VI was voided when the gold price dropped below $610. The declines have extended to 23.4% in the Comex 2nd month contract ($733.3 to $562.0 = -$171.3) and 21.7% in the London PM fixings ($725.0 to $567.7 = -$157.3). In the cash market in London there was a brief probe into the $540's, producing a decline of around 25% from the peak levels.

These declines mark the largest correction in the bull market to date and are in the 20%-25% range that was expected for major Wave TWO. The logical conclusion is thus that the market peaked in Major Wave ONE at the 12 May 2006 peaks of $733.3 on Comex and $725.0 on the PM fixings and is now busy tracing out Wave TWO. The 20%-25% range was determined by adding 50% to the approximate 16% magnitude of waves II and IV in major Wave ONE. We have not had a correction of the Wave TWO magnitude in the bull market to date, so we have nothing historical to guide us and the decline may be greater than 25%.

The good news is that if the market is indeed in Wave TWO, it establishes where the gold market is in the Elliott Wave cycle and, perhaps more importantly, the bulk of the probable decline has already been seen. In fact, the sizes of the declines to date are already of a magnitude adequate for Wave TWO, so there is a possibility that the lows of the correction are behind us.

As Wave TWO is the largest correction of the bull market to date, it is likely to extend for some further weeks or months and the initial down move may only be the first wave in a more complex sequence of minor waves within Wave TWO.

This assessment raises some issues relating to the minor waves in wave V. These issues will be addressed later. Firstly, let's look at the overall picture of major Wave ONE.

Wave III at $134 is just marginally larger than wave I at $126 in dollar terms although smaller in percentages, just sufficient to avoid Wave III being the smallest impulse wave in the sequence. The analysis of Wave V would now have to be as follows:

In this analysis wave (iii) of V is the smallest of the 3 impulse waves, which is a no-no in Elliott terms and thus casts doubt on this interpretation. This is one of the issues mentioned earlier and is discussed below. The PM gold fixing chart now looks like this:

The prior 4th wave of lesser degree is now the correction in the range from $572 to $535 depicted between the red lines straddling the $550 level, a common pull back point, which has been achieved with the fixing at $567.7 on 14 June 2006 and during intra-day trade in London to around $545 also on 14 June 2006..

I have often been asked how it is possible for an accurate Elliott Wave analysis to be calculated when the gold market is being manipulated. This is probably an appropriate time to have this discussion as the views expressed have a bearing on the issue of the minor waves being of inappropriate sizes.

At the outset let me say that I believe that GATA has done a good job in fingering the points of manipulation in the gold market, although I prefer to use the word distortion. The main areas where interference with normal market patterns has taken place are:

  1. Excessive short selling in futures markets either to extend a decline or prevent a rapid upward price thrust;
  2. Selling of physical gold by Central Banks;
  3. Leasing of physical gold to facilitate hedging or carry trade activities.

It should be noted in points 1 and 3 that for every downward price distortion caused by excessive short selling there should also be a countervailing upward price distortion when the trade is unwound. In the case of excessive selling of futures, these short positions will have to be closed eventually by corresponding subsequent purchases. Hedging and carry trade activities are unwound by buying back what was sold or by delivering newly mined gold back to the Central Bank that supplied the leased gold, thus reducing physical sales to the market.

Selling of gold by Central Banks has had the purpose of limiting the gold price rise. A sharply rising gold price would attract attention to the rapidly declining purchasing power of the irredeemable currencies that all countries now issue. This artificial lid on the gold price will in due course (already happening) attract the attention of countries accumulating large surpluses, mainly of US dollars, resulting in purchases of gold for reserve purposes.

In other words, all these distortions tend to be of relatively short term duration, and are followed by countervailing upward distortions. The underlying primary trend of the market will always flow through to be expressed in the major waves while the distortions will tend to be apparent in the minor waves.

For this reason I have been prepared to ignore areas in the minor wave counts where Elliott rules are breached and rely more heavily on the major waves to determine the wave count. For the record, here are examples of notable distortions apparent in the wave counts.

  1. An example of selling extending a correction: The correction in May 2004 which was expected to terminate after an 8% decline from $425 to $390 was extended to $375, a 12% correction, by excessive selling. (Wave (iv) of wave III).
  2. An example of an explosive upside move being halted: In December 2004 the gold price was roaring towards $500 but was stopped dead in its tracks by an avalanche of selling at $454. This simply prevented a rapid additional $40 up-move, which would have been followed by an equally rapid $40 decline. (Wave (v) of wave III)
  3. An example of an upward price distortion taking place is the recent stunning run up to $725. One would normally have expected this large $190 rise to be caused by a binge of speculative buying which would have resulted in Comex open interest zooming. This didn't happen. Open interest declined, indicating that short covering was driving the price higher. Similarly in the physical market there were signs of hedgers covering their positions and central banks accumulating gold, e.g. Iran.

The following is a comparison of the original forecast of Wave ONE with the actual outcome.

The original forecast back in August 2003 was made when gold was around $360 and a call for the peak of wave ONE to be $630 was a bold one. By and large the major wave forecasts have stood up reasonably well. There were 2 important distortions, the first being that the peak of wave III was $454 not $500 as anticipated due to the selling referred to in example 2 discussed above.

This resulted in the following corrective wave IV being smaller than the anticipated 16% but the lows for wave IV were very close to the $420 level forecast. Wave IV was a triangle that lasted nearly 9 months. The figure of $411 was the lowest price in the triangle while $418 was the bottom of the final wave at the apex of the triangle. The second important distortion was on the upside during the recently completed Wave V. This is the upward distortion mentioned in example 3 above.

This is an explanation of why it is possible to ignore some of the inconsistencies in the minor wave counts. Enough good undistorted data does get through to enable worthwhile forecasts to be made. As the bull market progresses and there is a much greater participation in the gold market, one would expect the impact of these distortions to become much smaller.

It should be remembered that gold is unique amongst commodities in that it is produced for accumulation not consumption. This has important consequences. In the case of a metal like copper, when demand exceeds supply and stocks are drawn down to near zero levels, the price will rise in order to ration the available supplies. A trader caught short in such circumstances has no choice but to bid up the price savagely in order to cover the short position. In the case of gold, most of the gold ever produced is still available in some form or another. Higher prices thus flush out profit takers allowing traders with gold short positions to cover more easily than in the copper example. It also means that corrections in the gold market can be quite large following very large gains.

Now that we appear to have reached the peak of major wave ONE at $725 we can make some guesses as to the peak of the big major Wave THREE which will follow once the current Wave TWO correction is completed. We now know that the $725 level is 2.83 times the $256 start of the bull market. We can project that the peak of Wave THREE will be at least 2.83 times the low point of this correction. As Wave THREE could be the strongest of the bull market, it is possible that the multiple could be higher, possibly 1.618 x 2.83 = 4.58.

If the low of wave TWO turns out to be, say, $545, the recent intra-day low, the following would be the targets for the peak of wave THREE:

$545 x 2.83 = $1,542.00
$545 x 4.58 = $2,496.00

The 2 largest corrections during Wave THREE should be of similar magnitude to the 16% corrections experienced in Wave ONE.

Before we get carried away with the potential of Wave THREE we need to be sure that the major correction currently underway as Wave TWO is over. While the decline to date is adequate for the magnitude expected for this major wave, it is possible that the first down-leg is only the a-wave of an a-b-c (or possibly more complex) sequence. It is quite possible that the correction may absorb several more weeks or even several months.

On a personal note, I will be travelling in China, Europe and Africa during the next 6 weeks and it is unlikely that I will be able to produce any reports during this period.

SUMMARY

  1. The decline below $610 voided the scenario set out in Update VI
  2. The recent plunge has been the largest of the bull market to date, reaching into the 20%-25% zone that was expected for Wave TWO.
  3. The probability is that $725 marked the peak of major Wave ONE.
  4. The consequence of this is that there are inconsistencies in the minor waves forming part of wave V of Wave ONE.
  5. It is possible that these inconsistencies and distortions have been caused by deliberate manipulation of the gold price.
  6. These distortions relate to several spheres but downside distortions are eventually followed by distortions to the upside. Consequently it is possible to accept that short term minor waves my not accord with classic Elliott Wave patterns.
  7. If the low of Wave TWO is in the region of $545, possible targets for the peak of the strong Wave THREE to follow could be of the order of $1,542 or possibly even as high as $2,496.
  8. Wave TWO may have covered an adequate number of dollars to the downside, but the initial down wave may only be the a-wave of an a-b-c or more complex wave sequence. If so, Wave TWO will absorb several more weeks or months and may exceed the 20%-25% size expected for the current correction.

Alf Field

Comments may be made to the author at: ajfield@attglobal.net

Disclosure and Disclaimer Statement: In the interest of full disclosure, the author advises that he is not a disinterested party in that he has personal investments gold bullion and gold mining shares. The author's objective in writing this article is to interest potential investors in this subject to the point where they are encouraged to conduct their own further diligent research. Neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock, currency or commodity. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions. The author has neither been paid nor received any other inducement to write this article.

Alf Field was born and raised in South Africa. He is a Chartered Accountant by training. Together with a partner, he started his own funds management business in 1970 in Johannesburg. In August 1971, when the USA stopped converting US dollars for gold at $35, Alf perceived a major opportunity to buy large quantities of gold mining shares personally and for clients. In 1979 he migrated with his wife and four children to Australia. He is currently a self-funded retiree who manages his own portfolio. In 2002 Alf started writing articles on gold related subjects, including monetary history, as well as a series of gold price forecasts using the Elliott Wave technique.

The total world's holdings of gold could be transported by a single solitary oil tanker.

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