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July 11, 2006

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Gold – Bull Market or Just Plain Bull?

Name: Chad Butler

Company: RJO Futures

Learn More About Today's Author
Years Trading : 16

Favorite Movie : Glengarry Glen Ross

Gold – Bull Market or Just Plain Bull?

There are quite a few pundits out there that have recently said the so-called commodity bubble has burst, and, more specifically, the bubble in gold has burst.  While we did take advantage of some bearish option positions during the downdraft, my longer-term outlook never changed.  In fact, I reiterate my position that we are in a long term bull market in commodities that does not currently show any signs of stopping.  (For some background on this, I suggest you read my May 26 TraderSavvy article, “Long Live Commodities”. View it at:

Today’s article will focus specifically on the Gold market in the scope of this larger cycle.  Since this article would not provide enough space for us to dissect the bullish scenario of the market based on fundamental analysis, we will focus primarily on a technical analysis approach.  By doing so, I think there is a little something in here for everyone – gold traders, market technicians, trend followers, and maybe even a little something for the fundamentalists and market psychologists.

A mere matter of months ago, everyone was clamoring to get on board the gold train.  Then, without warning (or was there?), the market made a hard break and took out many weak longs with it.  So, where are we now?  Should you go with the longer-term trend and buy dips?  Or is it prudent to be selling rallies?

Well, some of that depends on you as a trader, but overall, the general approach to this market is the long side.  True, Gold is at historically high levels, and markets don’t go up forever.  But let me give you an analogous market situation - Internet stocks of 1998.  Quite a few traders saw the ridiculousness of those stock valuations.  They did the only thing that made sense in that scenario – they shorted the market.  But a lot of them were forced to throw in the towel long before the market peaked in 2000.  Gold is high now, but how high would you be willing to let it go before you threw in the towel?  $800?  $1000?  $1500/ounce?  The truth is we don’t know how high it will go.  We just know that the trend is our friend (until the end).

Before we can trade this market, we need to determine the trend (so we aren’t on the wrong side of it).  I like to do that using some simple moving averages and a MACD that complements those moving averages.  To me, the relationship between the 9 period and 50 period simple moving averages is key to determining trend on daily, weekly, and monthly charts; and that for long-term trend trading, the relationship between these three time periods is also key.

Beginning with the August contract (the front month), let’s look at the 9MA and the 50MA on the daily.  The 9MA, representing the short-term money pressure on the market, is below the 50MA, which represents the long-term money pressure.  This situation by itself is bearish.  However, these indicators for me do not exist in a vacuum.  Other critical pieces of information are needed to tell the whole story.

Chart © 2006 FutureSource

For starters, I also consider the 20 period Exponential Moving Average, which gives more weight to recent days’ activity than those farther in the past.  In the case of the daily chart, we have not only recaptured the 20EMA, we have gotten follow-through buying after that initial breakout.  The second factor I need to consider is my MACD.  I use a 9/50/50 compression on the MACD in order to complement the time periods I am watching with my other moving averages. (To not do this is a common error, in my opinion, of using the MACD in combination with other tools.  If you are looking at a momentum-based relationship on conflicting timeframes, how can you get a valid look at the market?  But that’s a dissertation unto itself.)  Here we have the MACD set up for a potential crossover, which could indicate a momentum shift to the upside.

Before we get excited, we need to stop and take a look at the longer term picture.  If we are looking to enter the market in a trend following trade, we need to know if we are in line with the longer term trend.  To do that, I look at the weekly chart.

Chart © 2006 FutureSource

Some key things we notice on the weekly is that the 9/50 MA relationship is bullish (the 9 period MA is above the 50 period MA).  The second, and probably more important, is that the market broke the 20 period EMA, then very quickly regained that area.  This indicates a technical rejection of lower prices and is a signal to be looking for areas to buy the market.

The daily and weekly charts are indicating that we need to be long gold, but I am not one to jump into the market without confirmation.  We have to hold back here just a moment and say we need confirmation of that momentum crossover on the daily chart in order to be in the market.  I’ve marked the 650 area as a key price area on the chart.  It was a previous resistance area and is also a psychological area.  A breakout of $650 would not only be a breakout of resistance, it would also likely pull the MACD into a bullish crossover.  That price, however, is a little way off and there is room in there to use a lower price as an entry trigger if you are more aggressive. Entering on a buy stop above Friday's high of $639.50 would be a good entry point.

My usual method of market entry in trend following is to buy on a stop, and if filled, I would place a sell stop in case we are wrong and do not get follow-through buying.  Were to place the stop is a matter of your personal risk tolerance; there is no one right place.  There is, however, a very wrong way – using an arbitrary dollar amount.  That is a critical mistake make by a great many traders.  Using $500, $600, $1000 as your risk has nothing to do with the technical areas on the chart and this method of stop placement often results in locking in a loss.

Instead, let the market determine your stop.  (And if the key price levels are too large for your risk tolerance or account size, you should stay out of that market.  In terms of gold, there is also a smaller contract at the CBOT you can use if you fall into this category.)  Some key areas I would look at would be 600, 580, and 550.  Now these might be a little aggressive but this is a volatile market now with some very large swings.  I cannot emphasize enough that if you can’t stomach that big of a swing, you should consider another market.

On the upside, our initial profit target would be a run to the old highs.  Depending on how the market reacts (if we go there) will determine whether I would look for it to push through or if I would take profits.  We need to wait until we get there to make that call.

So we have our market outlook, a trade setup, our risk control, and an initial profit target.  As I said before, if the risk in the futures is too great, you might want to consider another market.  Options might be a good place to start and we put out option trades weekly in our options newsletter.  Also, this week, I will be releasing a special report on gold.  This report will cover fundamental analysis of the gold market (and by default, the dollar), as well as more insight into the technical picture.  Also included will be additional trade ideas in both the futures and the options.  Pre-register today to receive this report upon its release.


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