Thursday, May 24, 2012

Gold on the verge of a new phase of development? What I am looking for..

(There is what I believe to be a "treasure trove" of insights in the comments section at the end of this post that are worth spending time on.)

Let me start by saying I completely understand that there are valid reasons to buy gold for the long term as insurance and for savings.  I also don't make trading decisions based on fundamental analysis.     

Futures trade in a two way auction.  Price is determined only by whatever amount someone is willing to bid or offer at a given moment.  This is the truth.  If the fundamentals are bullish, and the auction is bullish, a good trader is only going to be on one side of the trade, the right side.  But if the auction is bearish what good are fundamentals?  An Auction Market Analyst knows that the fundamentals will come out eventually, but by the time the "experts" have it right and are "genius" with the explanations after a move happens, the damage has been done unfortunately.  An auction market analyst should never need anyone else's opinion for confirmation.  The confirmations are on the chart.

I have been asked about the structure of the COT report in gold and how the large speculators have low open interest that hasn't been seen in a while, and if this is a buy or hold signal.  This goes back to the "myths of trading".  What is low today is relative to yesterday and not tomorrow.  What is preventing the large speculators NET long position from becoming a NET short position?  Each month you can hear the same story about the COT report being even more bullish while gold can plunge.  I'm not predicting this; what I am saying is that COT analysis is only one important piece in the complete study of auction market analysis.  I certainly don't believe it is a reliable timing tool.  I have developed my own proprietary indicator that provides a score for price, volume, profile, open interest, and the COT report and I look at these for whether or not there is an "edge" in the supply and demand probabilities and for determining position sizing.      

Let's go to the chart.  There is a potential lethal "Descending Triangle" on the daily chart that is LARGE, (see right hand side below).  A descending triangle shows increasing supply and weakening demand.  When this prior demand throws in the towel and sells below the horizontal support level because they are in the "red", it increases the supply side pressure, which can cause the floor to cave in if there are "weak hands" on the long side of the current open interest.  What is a weak hand?  A trader who trades too big for his mental capacity or uses too much leverage.  This old demand would likely be "gun-shy" in the near term.  This can lead to "Vertical Development" or a market that is in "imbalance".  Where is the stopping price going to be where supply equals demand again, nobody knows.  I can tell you this much, once I have correctly identified the phase of development a market is trading in a given degree of timeframe it is absolutely critical for me to stick to my rules.

I have been looking to invest for the intermediate to long term in gold but I also have no interest in having my head handed to me on a breakdown.  What I will be looking for is a failed breakdown in order to get comfortable with taking risk on the long side.  This would be a sign that "strong hands" are accumulating.  But in the meantime, a breakdown with an "Igniter Move" is not what I want to see.  You can buy it all you want, I just don't have any desire for bargains in this business.

(Click on chart to expand)

What else is there to keep an eye on?  Should "Major Support" hold and gold next breaks the upper trendline resistance of the triangle, this could develop into a very LARGE "Triple Bottom" pattern with extreme bullish implications.  That is down the road, but intuitively I see it as a potential development to keep an eye on.  I'm paying attention to the triangle in the meantime until something changes.  I don't think it is wise to trade early in anticipation of any move. 

On a side note, there was a textbook "Symmetrical Triangle" intraday today on the 5 minute chart.


  1. Scott,

    very good article on gold--I think the problem many new and old gold traders have is that they base their trading on fundamental analysis--they are constantly bombarded with articles why gold is going up, the bottom is in ..etc--
    they have no clue about trading and what to look for.
    i should know since i used to be one..but thanks to you and your blog i have seen the light and now looking at trading in a new way.
    So keep up the good work..have a great long weekend .

    1. If you are doing better trading you deserve all the credit. But I sincerely thank you for the compliment.

      Have a great weekend as well.


  2. "my own proprietary indicator that provides a score for price, volume, profile, open interest, and the COT report and I look at these for whether or not there is an "edge" in the supply and demand probabilities and for determining position sizing"

    Keep in mind that COMEX is only part of the total gold market and larger volumes, stock and positions are held out of view in the OTC market. Indicators just based on COMEX may therefore not reflect the actual market supply and demand.

    1. Thanks for the comment Bron.

      I say this with all due respect, I do not believe a precious metals trader should concern him/herself with anything outside the "auction market" laws of supply and demand.

      To be fair, someone who is deeply involved or an expert in the real world of physical precious metal probably shouldn't concern themselves with anything outside the "economic" laws of supply and demand either.

      With that being said, those with a large cash position or those who are in the business of mining, producing, processing or using the metal that want to utilize the futures market to either "hedge" or "speculate" based on their knowledge, should be teaming up with someone like myself (NOT a technical analyst. TA is a myth) in order to maximize their reward and minimize their risk.

      99.9% of what I do is "day-trading" but my principles apply to all futures markets in all timeframes. These principles of mine are valid, robust, and a logical approach to viewing auction market behavior.

      It is quite possible that the combination would lead to superior results.

      I'm all ears on any offers. The competition might one day regret you beating them to it.


  3. Scott, I agree that "a precious metals trader should concern him/herself with anything outside the "auction market" laws of supply and demand" it is just that COMEX or other futures markets are just part of the auction market for gold.

    If all you are looking at is the COMEX auction, you are missing the auction market occurring in the OTC forwards market. Statements like "greater the open interest the greater the speculation and/or hedging and vice versa" cannot be firm rules as there may be changes in speculative interest in the OTC markets that you cannot see which are driving gold's price.

    As an example, the Perth Mint refines and sells 300t of gold a year, which is about 10% of the global mine supply. We have never used any futures market nor OTC forwards. We are not alone. Therefore looking at COT may not be giving you the view full of gold auction market behaviour.

    Just saying keep that in mind when doing your analysis.

    PS, we do not speculate and we "hedge" ourselves by directly leasing gold and via our client's unallocated metal, so we do not need to concern ourselves with price movements.

    1. I sincerely appreciate the follow up Bron. What you say makes sense. I will however respectfully disagree with you that a precious metal "futures" trader should concern themselves with the OTC or forwards markets.

      I don't have an issue if you disagree with me.

      Keep in mind, I don't care what direction gold goes in, up or down, I have no position at this time. I am also not in the business of forecasting.

      Once I have correctly identified the phase of development a market is trading in, and then find what I believe to be a "favorable" trade location in regards to reward and risk, and based on the perception of continued supply and demand probabilities and I take a loss, I not only accept it, but I welcome it, as long as the trade had a "Positive Expectancy" at the time of entry.

      A positive expectancy is not based on the outcome of a single trade.

      Let me add that as complicated as futures Auction Market Analysis is, it's really the easy part of the job when compared to "Risk Management", "Money Management", "Trading Psychology", and "Trade Management". In my opinion without a firm understanding of those, a trader/analyst who uses leverage can be as brilliant as they want in the study of the metals markets, and they will most likely still get destroyed.

      It is better to be concerned with the probability for "ruin" than the probability for "jackpot".

      Perhaps you can share with us your perception of the supply and demand forces that are currently in play from your end?

      I thank you for sharing your insights and I appreciate your contributions to the blog.


  4. I don't think I understand you technique. If I told you I you would only get 20% of trades made on COMEX, 20% of volume, 20% of COT would your technique still work?

    Because that is the sort of relativities of COMEX supply/demand to the OTC "futures" market. It is also possible that bullion banks can "paint the tape" by chosing how much inventory to show in COMEX versus off market and how much (to a lesser extent) of OTC trading they will hedge on COMEX (and thus make it visible to you) vs laying off with other OTC counterparties or into ETFs.

    On ETFs, do you include that data into your assessment of the supply and demand probabilities?

    1. Thanks for the follow up questions Bron.

      Let me see if I can use an analogy with the emini equity futures. If I trade the S&P 500 futures (ES) and the Nasdaq 100 (NQ), should I concern myself with the price and volume on the ETF’s SPY and QQQ? Apple’s weight in the NDX is very high at times near 20%. Should I concern myself with what the shares of Apple are doing if I trade NQ? My answer to these questions is respectfully not in this lifetime.

      But let me make something clear. If it helps any other trader to keep an eye on all 100 issues of the NDX, or looking at how these companies are trading in afterhours or overseas markets, and this “homework” makes money that is what matters most.

      What I strongly believe and I will take this to the grave, is that the price movement of Silver futures (SI) is determined 100% by the supply and demand of (SI), and nothing else. I stand by the comment that an increase in the “open interest” of (SI) is an increase in “hedging and/or speculation” of (SI).

      Now perhaps there are opportunities for arbitrage, but I could care less about that strategy. JPMorgan Chase took a big hit trying to capitalize on “arbitrage”, and Long Term Capital Management bit the dust with it. This goes back to me saying previously, it is better to understand the probability of ruin than the probability for jackpot.

      Failing to look at OTC markets is not going to ruin me. What would ruin me is “me”. I don’t care if anyone “paints the tape”. What I care most about is how I react to “paint the tape”, which would be either capitalizing on opportunity, or staying out of the way.

      I am speaking for myself personally here. When it comes to the metals, if I looked at what was happening in London as an example it would be a distraction. It would lead to hesitation, indecision, second guessing, etc. In my opinion looking at other things, including a “technical indicator” or “moving average”, anything other than the auction taking place right in front of me, would be signs of a psychological disorder such as “confirmation bias”, “Illusory correlation” and “availability bias”, which are all deadly disease for the trader.

      Lastly, if whatever you or anyone else does “works” that is all that matters. I say this most sincerely.