Elliott Wave Gold Update VIII

Gold has been correcting for 4 months since the 12 May 2006 peak. It is time to consider whether the correction is nearly over or whether we can expect more down or sideways action.

It is important to have a clear understanding of the difference between corrections in the gold market as opposed to corrections in base metals. Base metals are produced for consumption, unlike gold which is produced for accumulation. The market price of a base metal is largely regulated by current supply of physical metal relative to the existing level of demand. If demand exceeds supply, above ground stocks will be drawn down until they are exhausted (e.g. nickel recently) at which point the price of that base metal will rise sharply to ration the available supply to the highest bidder. If there are short positions in the market, they will probably get flushed out at this time. A brief short squeeze will push the price above the equilibrium level and the base metal will then correct back to the equilibrium price.

In the case of gold, the metal is not consumed and large above ground holdings of gold exist. Thus there is generally plenty of above ground gold supply in normal circumstances to meet any exceptional demand. One should place an emphasis on "normal circumstances" because people who generally buy and hold gold do so because they understand the concept that it is the ultimate store of wealth and that gold provides protection against the inevitable demise of our existing world wide fiat currency system.

Data Updated to 30 June 2006

Not everyone who owns gold is a long term holder of the metal. Some are speculators and others may find that their circumstances change and that they need to cash in their holdings. The above chart gives us a picture of the gold price over a 75 year period on a quarterly basis.

What is significant is the 25 year base that formed under the $500 mark and the spectacular upside breakout that occurred in December 2005. When the gold price reached $730 six months later in May 2006, everyone who had bought gold in the past quarter of a century had a profit! Those people who had bought at $500 two decades earlier and watched the price plummet to the $250 area, not once but twice, could now see their money back plus a 40% profit. Those investors who had bought between $300 and $400 were looking at gains in the region of 100%.

With every gold holder staring at a decent profit, it is not surprising that profit takers came out of the woodwork from every direction above $700 and overpowered the buyers, causing the gold price to plunge to a brief intra-day low in London of $540. In Update VII the 12 May 2006 peak ($733 on Comex and $725 PM fixings) was identified as the peak of Major Wave ONE in the bull market and thus the correction was part or all or Major Wave TWO.

The initial decline to $540 was of sufficient magnitude to satisfy the dollar amount required for the Wave TWO decline, but it had happened too quickly. Not enough time had elapsed to allow for all the profit takers to get out and new long term buyers to come in and take their place, thus building up a solid base of holders with a cost entry in the $540-$730 range. This is a necessary building block in the market to provide the support for higher prices to come.

I surmised that the decline was only the A wave of a bigger A-B-C correction which would absorb several more weeks or months. We are now four months into the correction and possibly coming to the end of the corrective period. This is the graph of Comex Gold now:

Data updated to Friday 8 September 2006.

There are a couple of interesting points on this graph. The Island Reversal formation in June is a fairly reliable indicator of a change of trend and it worked, at least for the moment. Gold gapped up above $600 and quickly moved to $660 plus at which point those people who had missed out selling the first time around came in saying that this time they were not waiting for $700 and dumped their positions.

The second interesting observation is the strong support line just above $600 which has contained the 3 declines over the past couple of months, a level reached again last Friday, 8 September. The question is whether this level will hold again. If it does hold then there is the potential for gold to move rapidly above $700 in the near future. If this is the case we could label the peak at $674 on 14 July 2006 (Comex) as the peak of wave (i), the first upwave in the new bull leg and the correction to the recent $608 level as wave (ii).

If this support level just above $600 gives way, then we should expect another visit to the lower $500 regions. That would then confirm that the 14 July $674 peak was the end of the B-Wave and that the decline to test the lows above $500+ would complete the C-Wave. That would also complete Major Wave TWO, the biggest correction in the gold market to date.

In some ways another test of the $500+ 25 year base break out level should be expected. This is typical technical action after such a massive upward break. It is what is sometimes referred to as the "Good-bye kiss". The price touches the breakout level and then takes off. If this happens, any price in the $500-$550 range would provide a great opportunity to add to gold and gold share holdings.

LATE NOTE: The piece above was written during Sunday night New York time. I have just observed that gold has declined in Asian markets early Monday morning to the $596 level. I am not sure how genuine this price is. We need to see what the London and New York markets do, particularly the London Fixes, before jumping to the conclusion that the support level above $600 has given way.

Alf Field
Comments may be made to the author at: [email protected]

Disclosure and Disclaimer Statement: In the interest of full disclosure, the author advises that he is not a disinterested party in that he has personal investments gold bullion and gold mining shares. The author's objective in writing this article is to interest potential investors in this subject to the point where they are encouraged to conduct their own further diligent research. Neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock, currency or commodity. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions. The author has neither been paid nor received any other inducement to write this article.