Tuesday, March 20, 2012

Metal markets are bottoming out - MarketWatch

  By Avi Gilburt

We have had quite a nice and successful run in the metal markets over the last year. For example, you may recall that on Feb. 25, we explained that we expected one last push up in the markets, after which, a correction would ensue. In our trading room on Feb. 28, I suggested that traders exit their short-term metals positions, and some to even short the market.

The next day, the precious metals entered into what some termed a "flash crash" of its own, and proceeded to begin a corrective decline. Our thoughts were that the correction would potentially target the 30-32 region in the futures, and the 158-161 SPDR Gold Trust /quotes/zigman/41663/quotes/nls/gld GLD +0.18%  region.

As you know, this past week we dropped right into our target zone for this correction. So, the question many have been asking is what is going to happen in the market now.

What I have recently noticed on investor sites, such as Seeking Alpha, is that a predominant sector of the readership and contributors are normally quite bullish with respect to the metals. However, at this point in time, there seems to be more bearish calls, as well as some confusion. In fact, one article even cited that Jim Rogers and Marc Faber are both bearish on gold at this point in time.

Additionally, on CNBC Friday afternoon, there were two shows back-to-back after market hours where they suggested a short trade on gold in the first segment and the next had a segment entitled "Gold: The Glitter is Gone."

I have always found it interesting how so many become so negative on the metals once they witness a drop in the market. In fact, the drop occurred right after many people and market "gurus" entered the market, expecting a further breakout. These market "gurus" have been so badly whipsawed over the last year in gold, I am actually surprised that many of them are still in the market, and even more surprised that many investors continue to follow their advice.

But what has always astonished me is that, outside of the investment world, people have always prided themselves upon being able to find "the deal" with their acquisitions of cars, houses, clothes, etc., but do not seem to be able to bridge this perspective over to the financial markets. In fact, the opposite is often quite true.

This phenomena actually prompted me to write an article on MarketWatch not too long ago (" Riding the Elliott Wave to amp up gains ," on Feb. 17), which many of you have read, and which was designed to alert investors to this psychological phenomena, so that investors may be aware of market psychology before they make their next investment.

However, at this point in time, I believe that we are quite close to a bottom in the metals markets. In fact, such a bottom would be the base from which an exceptionally strong rally should begin. Since many market participants are now entering short positions, at least according to some articles written on Seeking Alpha and suggestions made on CNBC, their short-covering may add more fire to this expected potentially strong rally.

For those who question the potential power of the expected rally in the metals, please refer to the beginning of 2011 in the silver market, when silver went from 27-50 in three months. While GLD did not begin this type of rally until several months later, it went from 144-186 in just under seven weeks.

At this point in time, gold and silver seem to be displaying mirror patterns, and will likely move up in tandem, as they did from their respective market bottoms at the end of 2011. In fact, both can see the type of parabolic rally that was seen last year, and potentially even more powerful due to being in a stronger wave degree.

It is possible that we may have bottomed just above the GLD 158 level and at the 31.60 level, which is slightly below our top target of 31.90. However, I think we may still see one more decline that takes us toward the 158 level, and possibly slightly below it, and maybe as low as the 30.50 region in the silver futures, although a double bottom is not out of the question. Since we still do not have an impulsive move up from the lows made this week, we cannot be confident that the low is in. However, any further small decline should represent a significant bottom for both metals.

Since our analysis of third waves utilizes "Fibonacci Pinball," we can set, in theory, relatively well-defined targets for both markets. Assuming that silver has bottomed or even may make a double bottom, which is common for silver, I would expect the first target for silver would be the .382 extension (36) or as high as the .618 extension (38.70), before a smaller consolidation, on its way to the 43 region, which is the 1.00 extension. Of course, if silver does drop to the 30.50 level, then we will modify the target levels to the upside.

As for GLD, assuming a bottom at 158, the targets would be 168 (.382 extension) or 175 (.618 extension) before a smaller consolidation, on its way up to the 184 level.

Since this pattern is has an 85% probability in my humble opinion, there is always a 15% chance that this pattern will not play out, and that is why I suggest a stop just below the GLD 154 level. This provides for a low-risk/high-probability entry, with a defined point at which you would exit the market with a small 3% loss, but with much larger potential gains, which could very well exceed 20%, and multiples of that if you use options.

As for silver, there is also the 15% possibility that the pattern fails. This is why I always trade with stops, which I suggest just below the 30 level in the futures, and even use out-of-the-money hedges in the silver market, due to its volatility.

Although the suggested stop is a much larger stop than I would normally set, the upside potential is for silver to move up by 40% relatively quickly, and, thereafter, potentially double, so I believe the risk is well worth it at this time. Once silver begins its move up and confirms the pattern, I then suggest hedges to be removed, and stops moved up to the actual low.

Disclosure: Avi Gilburt is long the GLD and SLV.

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