Following up on my urgent issue on gold last week, I want to explain the details of what I am seeing.
First, although gold did close Friday above a minor buy signal at $1,289, it FAILED to close above the weekly buy signal at $1,320.
This is significant. It means that gold’s rally is merely short-term in nature, and not even strong enough to execute a weekly buy signal.
Now, it’s entirely possible that we may see the $1,320 weekly buy signal hit this week, or even next. Gold could rally a bit more.
But the mere fact that gold tested $1,320 last Friday and failed to close above it is a tell-tale sign that the underlying strength of the current rally is not as strong as one would think.
More importantly, the trading action in gold is NOT bullish. Please pay close attention to this chart.
I have labelled the four important items I want you to look at.
First, item #1 at the top of the chart. Notice the expanding, triangular type of formation, labelled a-b-c-d-e.
This is a corrective Elliot Wave structure in a fourth wave position, which should be followed by a collapse into a new leg down, a fifth wave.
The overthrow at the top, near the “e” label, is typical of this type of formation. It serves to sucker in weak buyers, just before the market turns back down and thrusts lower.
While I don’t rely on Elliott Wave for trading, I do use it from time to time as an additional tool to either confirm or deny my other work.
In this case, it completely confirms that the recent rally is corrective in nature, and not the start of a new bull market.
Now look at item #2 on the chart. You will notice that during the recent gold rally, the total trading volume declined at a rather substantial rate.
In a decent bull market rally, you would expect to see increasing volume. Declining volume, as you see in this chart, is NOT supportive of a new bull market leg higher.
To the contrary, it is supportive of a counter-trend corrective rally, and nothing more.
Now look at item #3 on the chart. This is what is called “open interest” in the futures market. It is the total number of gold futures contracts outstanding, long and short.
Rising open interest indicates that new money is coming into the market.
Conversely, declining open interest is typically a sign that investors are leaving the market. Long positions are being liquidated. Short positions are being covered. End result: The total number of outstanding contracts, the open interest, declines.
As you can clearly see, in addition to declining volume, the recent gold rally was also accompanied by declining open interest.
This is a bearish sign for gold. It essentially means that no new money came into gold during the rally — and instead, the rally was comprised mostly of longs getting out and prior short positions being covered.
Now look at item #4. This is an indicator that measures the relative strength of the move. When overbought, it usually means the rally has reached an extreme, with readings over the 70% line, the top thin horizontal line on the chart.
Notice the red portion above that line, where I have drawn a green circle for you. Gold is extremely overbought right now.
More importantly, gold is now more overbought than it was during the rallies of late July, August and October of 2013.
The July 2013 rally led to an immediate $76.60 decline. The August overbought rally, to a whopping $140.60 decline.
The October rally, a $99.40 decline.
The average decline of those three prior rallies, $105.53.
If gold were to top at Friday’s intraday high of $1,329.90, a $105 decline would take it all the way back to $1,224.
On my systems, when corrective bear market rallies occur, sell signals move up much closer to current market activity.
The current rally has done exactly that and generated several new sell signals that I think are important. They also support my conclusion that the rally was nothing but a bear market bounce.
Those new sell signals are $1,318.50 … $1,251.30 … and $1,273.
This means that any decent move back down now could easily trigger sell signals and put gold back on a path toward new record lows for its three-year bear market.
That is especially true of the sell signal at $1,318.50, which is merely a few dollars under gold’s current price.
For all these reasons, and more, I strongly believe that gold’s recent rally is a bear market rally, one that could end at any moment — and lead to a sharp new thrust lower.
Ditto for silver and mining shares.
To sum up (and address some other issues as well):
1. The January low I was expecting turned out to be a rare cycle inversion. Instead of a new low, gold rallied. In addition, a cycle inversion often means the next cycle low will find prices fall further than expected.
Some preliminary tests I have run, as noted in my issue last Friday, now show gold falling to as low as $900 before it bottoms. It also shows two potential timing targets, this March, and May, for the final low.
2. The rally has the personality and structure of a correction, which will lead to a bearish outcome.
3. Volume contracted during the rally. That’s bearish.
4. Open interest contracted during the rally. That too is bearish.
5. As I have previously mentioned, the June/December 2013 double low is not a chart formation that is constructive of a new bull market. To the contrary, it’s indicative that a new leg lower lies ahead, one that will SMASH the $1,180 support level.
6. Gold is now extremely overbought, indicating an imminent move back down, with the first sell signal very close at $1,318.50.
What if I am completely, 100% wrong?
Nothing is ever guaranteed in the markets, so the next thing we must address is what kind of action to expect in gold if my analysis could turn out to be completely wrong.
If gold has already morphed back into a new bull market and the recent rally is the first leg up, then gold will still decline back to near the origin of the recent rally … hold support … and then begin a second wave higher.
That is how bull markets form. A leg up, followed by a pullback that retraces as much as two-thirds of the first leg up, and then a new rally to new highs, leading to a succession of higher highs and higher lows.
Bottom line: Even if I am dead wrong, we will still see gold fall back to as low as the $1,226 level, before it takes off again.
Put another way, if I am wrong, and gold has indeed bottomed, we will get a chance to play the long side at much lower levels than the current gold price, and with considerably lower risk.
Last week, you were stopped out of the ProShares UltraShort S&P 500 ETF (SPXU) when it hit my protective sell stop as the broad markets put in a violent short-covering rally.
Thus far, that rally appears to be much like the gold rally, nothing but a sharp corrective bounce.
I am monitoring the stock market very closely. I may recommend you get short again soon, so stay tuned.
Hold all other positions, including the natural gas ETN, VelocityShares 3x Long Natural Gas ETN (UGAZ). Natural gas is still in a bull market and on a path that should take it to over $6.00, with UGAZ rallying to well over $45.
Stay tuned and best wishes,