GOLD REVISITED
In my
first ever posting on this blog ‘To Buy or Not To Buy’, I said that gold and
silver were undergoing a major correction in an ongoing bull market, and that
although they were extremely oversold and a rally was imminent, once it had run
its course we were likely to see even lower prices.
That was
back in May 2012, and in the following few months we did indeed see rallies of
15% in gold and 20% in silver, however since those highs in September last year
both metals have resumed their declines and are once again oversold and near
some important levels of support.
So let’s
have another look and see whether the time is right to dip our toes back into
the water.
If we start with a current chart of the gold price we can see the rally that developed from the May low and the subsequent decline. It is also clear to see the zone of support that has developed around the 1530 area, this area has provided a buying opportunity on three occasions and as a result has now become critically important.
It is a similar story with silver.
It
is easy to see why some investors are starting to get exited,
feeling that the correction has gone on for long enough, that sentiment
in the sector is abysmal, that we are near to an area of major support
and that therefore from a contrarian investing perspective the time is
right.
Normally I would be amongst them, however there are a couple of things nagging at me and one of them is the zone of support.
As I mentioned earlier, this price zone has been reached three times, and each time there has been enough buying support to drive the gold price back up. The more the level works as support, the more confident investors get that it will continue to act as support, and as a consequence more of them buy gold when it gets around these levels. This works fine until the support fails, at that point many investors try to sell but because of the number of investors that are 'long gold' the price collapses leading to a stampede for the exit.
This can and does happen naturally, when normal sellers just overwhelm the number of buyers at a particular price. However it can also be engineered by some big players in the market that drive the price down through the support zone with heavy selling, creating a panic and a price collapse through the forced selling of investors long positions.
Once the price collapses and volumes rise, these same players that triggered the collapse go onto the bid side and buy back their positions (going long), knowing that once the dust has settled, the price will go back up because all of the potential sellers have now been forced out.
This may come as a shock to many of you but it happens on a regular basis in financial markets all over the world, and is a tried and trusted technique. Many years ago in my days working for an Investment Bank I even used it myself, so can vouch for its effectiveness. ( It can be argued that these practises, along with many others should be made illegal and you'll hear no argument from me. But until they are, if you intend to play with the big boys it helps to understand how they operate!)
With this in mind let us now take a look at the latest Committment of Traders (COT) data for gold. You may recall I have used this predictive tool in previous posts as it gives some perspective on what positions both the commercials (professionals) and speculators ('Joe Blow' investor) currently holds.
On this chart we can see the build up of 'short' positions by the professionals around the price high in September last year and the buying back of these shorts as the gold price has fallen. However, whilst their short positions have come back to a more normal level there is still plenty of room for them to engineer a further price fall and buy back more. It is important to understand that even though they have reduced their positions, they are still short gold.
Lets also have a look at silver to see if it corroborates what we have seen in gold.
With silver we can also see the extreme short position held by the commercials, and that they have also reduced their positions as the price has fallen. However it is also clear that they still have some way to go and that further price falls would benefit them greatly.
Lastly I want to look at a seldom used type of chart called a Point & Figure chart. These are different from ordinary charts in that they do not measure price against time. Price rises are marked with Xs and price falls are marked with Os, and if the price is unchanged nothing happens to the chart irrespective of whether the price is the same for a day, a week or a month.
They are interesting because the nature of the chart allows forecasts to be made as to future price movements. I don't intend to go into a detailed expanation of P&F charting here, but from looking at the chart below we can see that there is already a downside target in gold of 1365 and that should the price close below the 1533 level, another downside count will be activated around the 1100 level.
Lets have a quick look at a P&F chart of GDX which is an index of a number of gold and silver producing companies. For the gold price targets to have validity they should be matched by similar targets in the mining companies themselves as its hard to envisage a much lower gold price without a corresponding fall in mining shares.
And indeed we can see there is a downside target already triggered of 23.49 which would be a fall of over 30%.
It is very important to understand that these targets aren't set in stone, they can be reversed by price movements, and price can often fall short of the target. They are though an important tool in trying to fathom what a market will do and it is uncanny how accurate they can be.
So let's try to pull this all together.
On the upside gold and silver are both very oversold, under-loved and near to important areas of support, and the COT figures in both have moderated considerably from their highs allowing a possible rally to form. The danger however is that the support gives way, and there certainly are signs that were that to occur it could turn very ugly for a period of time.
I think the downside risks are too great at the moment and would rather wait until the picture is clearer, either by the price once again bouncing off support and the COT picture continuing to improve, or by the price crashing through the support level and seeing massive selling.
Either way I don't think we will have long to wait.
But be in no doubt,whenever it occurs the end of this correction will provide a great buying opportunity for the rally that will follow in the years ahead as the sovereign debt crisis explodes.
