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The current standoff in gold is approaching
resolution and evidence is starting to pile up in favor of an upside
breakout. We have been cautious on the PM sector for months starting with the
September top which we shorted, resulting in massive profits in a matter of
days, especially in silver, but there is always the danger of taking caution
too far and getting caught on the wrong side of the trade. Chart patterns
allow for all possibilities and there remains the danger of a downside
resolution, as we still have a Descending Triangle in gold and a potential
Head-and-Shoulders top in silver, and the downside potential of these
patterns would of course become reality in the event that the deflationary
scenario prevails, which could be triggered by, say, a major bank failing in
Europe, leading to an out-of-control run on the banks. That said, however,
there is no denying that both the COTs and public opinion, particularly for
the dollar and silver, are strongly bullish for the PM sector, and past
experience shows that it usually a costly mistake to trade contrary to their
indications.
It's time to make the call - to come down off
the fence and take decisive, resolute action, and the great thing is that you
(and I) can do this without fear of getting egg on our faces - why? - because
of the highly favorable risk/reward ratio that now exists for the sector, as
we will now demonstrate on the 2-year chart for gold.
 
Remember when gold was racing ahead and making
successive new highs back last August - September? It rose almost vertically
to open up a huge gap with its moving averages as it became wildly overbought.
This resulted in a highly unfavorable risk/reward ratio as shown on the
chart, which was why we shorted it and especially silver aggressively, but
now look at it! - the tables have turned and the
risk/reward ratio has now swung back to being highly favorable as gold has
become oversold and hunkered down beneath its moving averages. For sure the
pattern that has formed is a Descending Triangle which is often bearish,
especially as the price has dropped well below its 150-day moving average for
the 1st time since 2008. We are aware of this which is why we have noted the
positions of the exits, but we must set against this the strongly bullish
COTs and public opinion. Fortunately for us, the fact that gold found support
in December EXACTLY at its September lows establishes this level as obvious
crucial support - if this support fails it's probably curtains for gold at
least for a while as a deflationary bust would probably ensue, but if gold
can hold above it for a little longer, the chances of a blistering rally will
increase greatly, which will be triggered by a break above the red
constraining trendline that marks the upper
boundary of the Descending Triangle.
Even after the rally of the past 2 weeks,
which can be seen more clearly on the 6-month chart below, the risk/reward
profile is highly favorable, but should the price of gold drop back over the
short-term towards the support again, the case for piling on the longs will
be really compelling. This is because, in terms of the risk/reward ratio, it will
be a "no brainer". We may see just such a minor reaction over the
next week or two, for on Friday a "hanging man" candlestick
appeared on the chart after the "shooting star" on Thursday which
led us to take some profits off the table, and there is considerable
resistance just above the current price near the falling 50-day moving
average. Both these candlesticks are bearish, although they are rather small
so we are only looking for a short-term reaction back towards the major
support. If we do see such a reaction it will be time to "back up the
truck" and we can do so without fear, confident that our stop, a little
way below the support is unlikely to be triggered. (don't
place the stop too close though, in case Big Money money
engineers an intraday dip below the support to shake people out). An actual
stop level is not given here in case Big Money gets to read this and decides
to run us out of our positions for a bit of sport. In the less likely event
that gold does not react back at all and instead powers through the red
downtrend line you should grit your teeth and buy, placing a higher stop
beneath the red line. On the site we closed out the Put side of a straddle
trade on the approach to the big support at the end of December and went long
the sector with a stop below the
support, due to the compelling risk/reward ratio, and we will be buying more
if we get the expected reaction in coming days.
A big negative for PM stocks is that that they
broke down in December from Diamond Tops, in the process establishing a zone
of heavy resistance near to the apex or nose of the diamond, as we can see on
the 4-year chart for the Market Vectors Gold Miners Index below. This
resistance will need to be overcome to abort the bearish implications of the
pattern, and traders may want to wait for that to occur before committing to stocks, and such waiting will not result in missing much
in the way of the gains, as the really big upside action would follow on from
the breakout above the apex resistance.
Unless we fall into a deflationary abyss this
certainly looks like a good time to start accumulating PM stocks from the
standpoint of sentiment, for as we can see on the Gold Miners Bullish Percent
chart below, sentiment is at the abyssmally low
levels that we would normally associate with a major bottom - this is the
worst it has been since the depths of the 2008 selloff.
The notion bandied about in some quarters that
gold is going to "disconnect from the dollar" is of course total
nonsense - how can it disconnect from the currency that it is primarily
priced in? It certainly hasn't disconnected from it in the past few months,
as can be readily seen by comparing the charts for gold with the charts for
the dollar from last September. The dollar has been powering ahead and gold
has suffered accordingly - and silver has been slammed.
Having reminded ourselves that the course of
the dollar is indeed important for the gold price outlook, let's now take a
look at the dollar in an attempt to figure out what lies in store for it. Our
assessment in the last update that the dollar index could storm ahead to the
high 80's now looks too optimistic, after further consideration of the latest
dollar COTs and sentiment indicators, and this is clearly good news for gold.
It now looks more likely that the current dollar rally will peter out at the
resistance zone and trendline resistance shown on
our 2-year chart below, especially as upside momentum on this rally is
considerably weaker than on the last one back in September, and it could end
immediately. If this assessment is correct then it has only got a little
further to run at best before it goes into reverse, and this "little
further" fits with one last reaction back in gold and silver that should
present a great buying opportunity.
The 6-month chart shows the two intermediate
uptrends and one downtrend thus far within the larger uptrend in the dollar.
As we can see the current uptrend, which has opened up a large gap with the
200-day moving average, is getting "long in the tooth". It thus
looks likely that the dollar will turn lower soon, probably after a final run
at the parallel upper channel return line shown. The entire rally in the
dollar from last August could be a 3-wave countertrend rally that is
approaching completion.
We thought that the Commercials had big long positions in the Euro back in
October, but just look at them now! If the massive back door funding of the
ECB by the Fed succeeds in doing the trick and enables the ECB to steady the
ship by means of massive QE under another name (can't call it QE - the masses
might recognise that), then the Large Specs are set
to be "taken to the woodshed" for the hiding of their lives. This
would also be great news for gold and silver, and
for commodity prices generally.
The extreme level of
Commercial long positions in the Euro are of course mirrored by their
extremely high short positions in the dollar, which are close to record
levels. This is a big reason why the dollar rally is expected to fizzle soon.
The public at large, who make it a point of
honor to be always wrong, as a result of being clueless, are of course now
strongly bullish on the dollar, see below, another warning.
In conclusion it now looks like a really big
rally is incubating in gold and silver, and thus it is a good time to
accumulate ahead of the breakout, and there is a chance that we will be
presented with the ideal buying opportunity if we see a minor reaction over
the next week or two, as looks likely. The risk/reward ratio is good, and
will improve to excellent if we see such a minor reaction. If this assessment
of the outlook is wrong and a deflationary downwave
ensues soon, probably as a result of a bank failures
in Europe and a possible run on the banks, then we will be closed out on
stops for limited losses.
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