Gold Nears Peak

09/21/09 09:38:01 AM

by Alan R. Northam

Gold bugs are getting excited about buying gold once again since the precious metal is so close to making a new high, but caution is the order of the day. According to the Elliott wave theory, gold is about to go down and not up.

Security: GLD
Position: N/A

From early 2008 to late 2008, gold sold off in overlapping waves. From the Elliott wave theory, overlapping waves are known as corrective waves. The waves formed during market rallies occur in nonoverlapping waves. This is one easy way to identify market rallies and market corrections. Thus, the selloff during 2008 was a market correction to the previous market rally. Also from the Elliott wave theory, corrective waves are labeled with letters. I have labeled these waves with letters in Figure 1. The first three waves are labeled (A), (B), and (C) according to Elliott wave convention. These first three waves are known as a zigzag corrective structure. After wave (C) down is complete, the market rallies for three weeks and the peak of this rally is labeled (X). X waves are known as connecting waves that connect one corrective structure to another. Overall, the Elliott wave theory has identified 13 differing corrective structures, of which the zigzag is one. Since I have identified an X wave, it then follows that the market correction is not complete and there is yet at least one more corrective wave structure to complete before the correction in gold is over. Following the (X) wave, the next wave is a downward wave, labeled (A), which was completed in late 2008. Since I have identified an A wave, it then follows that there must be B and C waves left to complete before the market correction in gold is over.

FIGURE 1: GLD, WEEKLY. This chart shows the Elliott wave count for the market corrective wave structure.

Graphic provided by: StockCharts.com.

With wave (A) complete in late 2008, wave (B) is now under way and is yet incomplete. I have labeled all the smaller waves that have gone into making up wave (B) so far. I will not go into a detailed explanation of all these subwaves to save time. However, I do want to point out that the current ABC corrective wave is not a zigzag but an extended flat. An extended flat is a market corrective structure where wave B extends beyond the origin of wave A. In our chart I have identified the origin of our wave (A) with a red downward pointing arrow. I have also drawn a red dotted horizontal line to the right of the origin of wave (A). From this chart we can see that wave (B) has moved above the origin of wave (A). This identifies the current corrective wave structure as an extended flat. From the Elliott wave theory we also know that waves C of an extended flat also moves lower than the end of wave A. Therefore, once wave (B) is complete, we can expect the market to once again sell off to something less than $68.80. There are ways to determine a high-probability price target, but I will save that for another time.

The question now becomes, "When will wave (B) end and wave (C) begin?" To answer this question, we need to identify the last part of the wave (B) corrective structure that I have labeled (a) and (b) with wave (c) still in progress. Waves C are subdivided into five smaller nonoverlapping waves according to the Elliott wave theory. Of wave (c) I have identified four of those five nonoverlapping waves and labeled them as waves i, ii, iii, and iv. This leaves subwave v to be complete. Once wave v is complete, that will also complete wave (B) and signal the beginning of wave (C) down. Wave 5s are normally the same length as wave 1s. This then provides a high-probability price target for the completion of wave v and wave (C) to be 106.50. If wave iv is not yet complete, the price target for the completion of wave (C) will be somewhat less.

In conclusion, there is some possibility that my wave count is incorrect and an alternative wave count to be the correct wave count. However, what is correct is that the move upward in gold from the late 2008 low is made up of severely overlapping waves, which are corrective in nature and does not signal that a bull market upward rally is in progress. As a result, caution is the order of the day with respect to expecting this market to go much higher from current price levels. Wisdom would dictate that five nonoverlapping waves in the upward direction off a significant market low be identified according to the Elliott wave theory before labeling that a bull market in gold is in progress.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.