Today we are going to analyze the long-term technical picture in the Gold market and introduce you to another nuance of the Elliott Wave Theory. It’s going to get a bit more technical.
Up to this point we have primarily discussed the basic A-B-C pattern known as a zig-zag which follows the completion of an impulse or motive wave and looks like this:
Source: Elliott Wave Principle by Frost and Prechter.
In addition to the zig-zag pattern, there are three other primary variations: flat, expanded flat and triangle (which itself has several versions). We will not be discussing these variations in today’s article.
Regardless of which corrective scenario unfolds, the A and or C leg can have either 5 waves (motive or impulse) or can be a 3 wave structure (zig-zag or other variation).
A fifth wave, whether occurring at the top of an impulse wave, or the completion of the A or C leg of an A-B-C correction, can end in what is know as an ending diagonal and looks like this:
Source: Elliott Wave Principle by Frost and Prechter.
Now let’s look at the monthly chart of the gold futures market and compare it to our hand depicted diagram above.
Source: tradingview.com. Annotations: Author’s own.
In the gold futures chart, there is a clear impulse wave beginning in 1999 and running through 2011 (labels 1-5). Since then, it appears as though price has been declining in a five wave impulse as part of an A-B-C correction which is labeled (1), (2), (3), (4), (5). It is the final wave of this impulse wave which appears to be an ending diagonal and is labeled 1, 2, 3, 4, 5.
This smaller ending diagonal is the final wave of what I believe is the A leg of a larger ongoing correction in the price of gold that has yet to complete. The final tick of this ending diagonal is the December 2015 low in the price of gold and corresponds with the 50% Fibonacci retracement of the entire bullish advance between 1999 and 2011.
Since that December low, the price of gold has now broken out above the ending diagonal pattern in what I believe will be a B leg bounce which should ultimately take the price of gold to somewhere between $1,600 and $1,900 an ounce before the B leg is complete.
Once complete (assuming I’m correct in my assessment), gold would then drop back to either $1,000 – $1,100 an ounce and possibly as low as $700 – $800 an ounce, depending on which corrective pattern is unfolding: zig zag or flat.
Another possible scenario is that the correction takes on the form of a contracting triangle and the December 2015 low of $1,045 ends up being the nominal low of the entire correction.
And finally, it’s possible that what I believe is the low of the A leg, is in fact the end of the entire correction, and now gold prices are headed much higher over the next 3 to 10 years.
With all of these possible scenarios, I’m sure you’re beginning to see why so many people dismiss the Elliott Wave Theory as worthless rubbish. But in my opinion, this misses the value of what the pattern offers us in terms of an edge in the market.
Under every conceivable Elliott Wave possibility, the December 2015 low becomes an anchor point from which we can begin to work to draw some highly probable and reasonable investing and trading conclusions.
Let’s suppose you had been watching the gold market (as we were), looking for indications of a bottom to the correction that began in 2011. Assuming a basic understanding of the Elliott Wave Theory in conjunction with Fibonacci retracement levels as support, and knowing what a point of maximum pessimism looks and feels like. Then the dire headlines about the gold market in December 2015, coupled with both Gold Corp and Freeport McMoran significantly cutting or suspending their dividends altogether, in conjunction with a clear Elliott Wave pattern completion right at a key Fibonacci support level, when you combine these things together it significantly increased the odds that gold was capitulating and putting in some kind of tradeable bottom.
Now let’s look at every possible scenario and consider what you might choose to do:
- If the entire correction is over, and a new impulse wave is beginning, that means gold is super bullish and headed to new all time highs over the next 3 to 10 years. Under this scenario you would want to be long the gold market as a long term play.
- If gold has only completed an A leg down and is now working on a B leg bounce back to either $1,600 an ounce before reversing lower to $700 to $800 an ounce, in what ends up being a A-B-C zig-zag correction, or $1,900 an ounce before reversing lower to retest the $1,000 to $1,100 level in what ends up being and A-B-C flat correction, you would want to be long the gold market for some high probability intermediate term trading opportunities (1 – 2 year hold time).
- If gold has completed an A leg down and is working on a B leg bounce in what ends up being some variation of a contracting triangle before heading to new all-time highs, then the A leg low would be the nominal low of the entire correction and you would want to be long the gold market with long-term investment money (3 to 10 years).
- And if the A leg of the correction that began in 2011, that I believe ended in December of 2015, is still unfolding (very low probability), then the $1,045 low becomes a potential stop loss or exit point to reevaluate the first leg of the correction before embarking once again on one of the first three scenarios listed above. Of course, you will first have to identify what you believe is a new potential low to the gold market, if indeed the $1045 level is broken to the downside.
The way I see it, regardless of which pattern is currently unfolding, you should be long the gold market. And the current pullback in gold and silver miners we discussed several weeks ago is providing you with an excellent “second chance” to get on board if you missed the December 2015 low.
I will be the first to admit that the fundamentals in the gold and silver mining sector don’t look all that great right now, although they are improving. Furthermore, mining is traditionally a bad investment. It’s very capital intensive and resource/reserve depletive. Not to mention that over the last two decades mining companies have been poor stewards and have destroyed a great deal of shareholder value.
But I believe that is changing and is precisely why the opportunity in the mining sector is so good right now.
In the words of Howard Marks:
A high quality asset can constitute a good or bad buy, and a low quality asset can constitute a good or bad buy…
…In dealing with the future, we must think about two things: (a) what might happen and (b) the probability that it will happen.
At some point the piper has to get paid. The unprecedented amount of quantitative easing we have seen over the last several years has to show up somewhere. I believe that somewhere is the price of gold which will reflect a complete loss of confidence in paper currencies, central banks, and governments and will come with a healthy dose of inflation.
Just how high will gold prices rise?
I am not a fan of trying to forecast how high a market will go. I believe trying to pick a top is a mistake (I don’t believe that about a bottom). As John Maynard Keynes once said: “The market can stay irrational longer than you can stay solvent.”
Just stick with the trend, raise cash as markets look wildly overvalued, and mind your stop loss orders.
But since you are twisting my arm I will acquiesce and cry uncle.
Based on several Fibonacci projection levels and common wave relationships, the minimum upside target would be $3,169 per ounce to $3,747 per ounce and possibly higher if the loss of confidence really escalates.
The mining sector has just been gutted and trimmed of all its fat. If gold reaches the above prices, with miners running very lean, the future margins will be huge and quality mining companies will literally print money. Only it will be the real kind that governments can’t destroy.