Originally published September 30th, 2007
The way to be popular in this business it to tell people what they want to hear, which is that gold and silver are going up, up, up. However, if your priority is to assist people in making money or at least avoid losing it, then being popular has to be a secondary consideration.
Thus, in the last Gold Market update, an alarm was sounded over the rapidly increasing Commercial short position in gold, and a scenario was described in which gold breaks out to a new high amid great fanfare in the financial press, only to abruptly reverse. Gold has broken out to a new high and on Friday rose sharply to close at $750, and the purpose of this update is to assess whether further upside progress is likely, or whether it is now likely to consolidate/react.
There are 2 factors which taken together strongly suggest that gold is about to react. One is the RSI indicator shown at the top of the 2-year chart above, which remains at a critically overbought level. By itself this would not necessarily preclude further advance, as a commodity can remain very overbought for a lengthy period and yet continue higher. However, if we also take into account the fact that the Commercials' short positions in gold have risen to by far the highest level for a year, with a corresponding ballooning of the Large Specs' long positions, then a reaction would appear to be imminent. Before taking a closer look at the latest COT chart the point should be made that overall the gold chart looks strongly bullish, with a breakout to new highs, albeit still a marginal breakout, and moving averages in bullish alignment, suggesting that a major uptrend is still in its early stages. Thus, what we are concentrating on here is a probable significant near-term reaction to correct the current short-term overbought condition.
Turning now to consider the latest COT chart, we can immediately see that both the Large Spec long positions and the Commercial short positions have expanded significantly over the past week to reach a 1-year record, by a considerable margin. This is a setup that classically signals an imminent reversal. The one time that the writer intentionally went against such a setup he was buried in a hole so deep it took months to dig himself out.
So, if this interpretation is correct, how far is gold likely to react? A reaction back to the $700 area, where there is strong support, is considered the most likely scenario, and providing that there is a satisfactory drawdown in the Large Specs long positions and Commercials short positions, we would look to buy aggressively on such a reaction - both gold and gold stocks. Bearing in mind the bullish immediate outlook for the broad stockmarket, it is thought unlikely that Precious Metals stocks will lose much ground, even if gold and silver react as predicted, so the emphasis is not on selling PM stocks, but rather buying them on near-term weakness. We should keep in mind that the same forces driving the general stockmarket higher - the maintainence of liquidity and the continued ballooning of the money supply, are the forces that will fuel an acceleration in the rate of inflation, which is good for gold and silver.
