In the wake of recent earth-shaking events, as well as the broad commodity reversal set into motion back in July, let's look at the precious metals. Will these turbulent markets ever find their lows and
for staying the course, despite predictions of gloom and doom for the entire spectrum of raw materials?
Gold spent decades attracting a cadre of quirky enthusiasts with their Armageddon view of the world markets. Despite their intense interest, the yellow metal broke psychological support at $300 in 1997 and fell into a deep funk that lasted for almost five years. The futures contract finally emerged over that magic number in 2002 and never looked back.
Gold Futures -- Monthly
The long-term continuous contract for gold shows a three-phased rally between 2003 and 2008. The first phase printed a series of mild up waves that ended in late 2004, when the instrument stalled under $500. That barrier held back price for almost a year before giving way to the second rally in September 2005.
This uptrend was much stronger than the first one, with less overlap between monthly price bars. The surge lifted the contract more than 300 points in the next nine months, reigniting the public's love of the yellow metal. A second consolidation began in May 2006, carving out a triangle pattern that lasted into the middle of last year.
The final wave of the long rally began at that time, with an even steeper angle of attack than the 2005 move. This parabolic phase flamed out in March, giving way to the decline that shows a 1-2-3 structure off the high. The downside shows no signs of letting up at this time even though the instrument has lost nearly 20% in the last two months.
Technically oriented readers will recognize the Elliot five-wave rally set in the historic uptrend. This is certainly not a surprise, given that price action in the commodity markets routinely prints this type of pattern structure. The correction off the high is also following the Elliot playbook, with two strong down waves stuck between a failed recovery effort.
Gold Futures -- Weekly
The key to predicting the final target of this downtrend lies in the fifth and final wave of the prior uptrend. That move began at $546 and ended at $1,035. You'll note that price action off the high has stair-stepped along the 38% and 50% rally retracements, with the 62% retracement at $732 now coming into play.
The quality of buying interest at that support level will be instructive about the contract's outlook heading into 2009. A strong bid would signal the end of the downtrend and a long recovery phase. However, sustained rallies rarely follow broken parabolas so I'd be watching closely for a lower high to signal the start of an even deeper downtrend.
On the flip side, this weekly pattern points to significant downside risk if buyers don't show up at the 62% retracement. A second, more ominous characteristic of parabolas is they tend to get fully unwound before a market finds support. In other words, the door remains open to a 100% retracement that takes gold back down to the 2006 low at $546.
Silver Futures -- Monthly
The long-term silver chart shows obvious parallels to the gold contract. Its uptrend also carved out three rally waves, starting in 2003. It topped in March as well, with a spike over $20 giving way to a major decline. However, silver never printed an all-time high. That took place in the late 1970s when the Hunt brothers cornered the market.
There are other major differences between the two contracts. First, the silver decline has been more ferocious, with the instrument losing 50% of its value in the last six months, while gold has lost just 26%. And the white metal is now trading at the same level last struck back in June 2006, while gold is still holding its price from last October.
The selloff after the lower July high has ripped the guts out of this weekly pattern, completing a 100% retracement of the fifth and final wave of the long uptrend. This is a perfect illustration of the high-odds scenario I outlined for the gold contract. In fact, silver's decline could be a precursor for an identical selloff in the yellow metal.
Conversely, it appears that silver has hit, or is rapidly approaching, the downside target of its correction. Stabilization at current levels could eventually favor a countertrend recovery that lifts the contract back up to $15. That seems like small change in the big picture, but it would mark a 50% gain for those willing to assume the relatively high risk.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
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