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By: Costas Bocelli — September 19, 2013

Did the Fed Just Put Gold Back on Track?

The market seldom gets caught off guard.
 
But yesterday sure felt like a surprise party on Wall Street, and the guest of honor was genuinely surprised!

You see, practically everyone was expecting the Federal Reserve to announce that they would begin to taper the size of their monthly bond purchases.  They’ve been buying at a pace of $85 billion a month for nearly a year to help boost the economy and jobs.

And the debate leading up to the policy statement centered mainly on the question of “how much” will they taper, rather than “will they”.

Well it turned out that the Fed became the life of the party on Wednesday, because instead of announcing a taper, they chose to simply paint the tape!

With no stimulus cut, it quickly became a bull fest on Wall Street. 

The S&P 500 and the Dow Jones Industrial Average both closed at new all-time record highs.  US Treasuries rallied strongly, sending the 10-year bond yield back below 2.70% after recently testing 3.00% earlier this month.

The US Dollar index also plunged to a six-month low as the Fed’s balance sheet continues to grow at a swift pace and soon will approach the $4 trillion mark.

And most compelling of all was the huge reversal and massive rally in the price of gold.

If you’ve been following along over the past several weeks, my weekly column in The Tycoon Report has been weighted heavily on analyzing the price action in gold.

And since my August 15 edition, Will Gold Keep Riding the Wave?, and the follow-up article published just last week, Is Gold Carving a Path to $1500?, we’ve received tons of e-mails and comments from many of our readers and subscribers who keenly follow precious metals.

So with what transpired yesterday, let’s just say that the saga continues and has now turned into a three-part miniseries.

But first...

I never want you to be left confused

As I’ve been writing for The Tycoon Report over the past three years, sometimes I’ll refer back to a previous article as a reference.  I do this deliberately to avoid making repetitive statements, and it serves as an easy reference for readers who may have not seen the previous material and can quickly catch up with the back story and the subject matter.

My goal is to not only offer my perspective on the financial markets, but also enhance your financial education through my options and trading experience as a former floor trader on the PHLX exchange.

With that said, if I refer back to a previous editorial or educational piece, I’ll always include a link so that you can easily locate the prior material like in today’s article.

Here’s a timely example:

Several readers commented in last week’s follow up article that I completely disregarded the fact that gold has been trending lower for nearly two years and had completed at least two bearish wave patterns during that span.

Their observations on the movement in gold were indeed completely true and were actually used as a direct example in discussing Elliot Wave theory and how it relates to trading patterns.

But if you happened to read the original article, then you’re already familiar with the material and my acknowledgement that gold had been in a bear market for quite a while.  The chart that went along with the educational discussion on Elliott Wave looked something like this...

 
But hey, no worries, because if you ever miss a prior article that I’m referencing in a current piece, then the original subject title will be highlighted and linked for easy access.

Also in that original article, I brought to your attention that gold may have finally bottomed in late June, and that the bear market may be finally over.

At the time, I conceded the fact that it may be too early yet to make that call, but that the price action was on the verge of breaking technical resistance at $1350 which would extend a third wave.

And it did!

In last week’s article, we noted that a third wave was completed as gold broke resistance and ran to a peak of $1434 in late August.  Also, that trough to peak move was good enough for a 20% gain and did finally end a “definitional” bear market.

But following that peak, gold has been coming under pressure, as the fourth corrective wave was underway.

Also in last week's article, we noted that same key level of $1350 -- which was resistance on the way up -- now becomes a key support level on the way down.

If we were to be in the midst of creating a full five-wave bullish pattern, then that $1350 level should signal that a bottom in the fourth wave should soon be upon us.

Well lo and behold, last Thursday, which happened to be the publish date, gold plunged over $40 and traded down to $1320!

Of course that did not exactly make my bullish argument hold much credibility that day... and a few readers certainly reminded me of that.  But that’s okay, because I make hundreds of real time market decisions a year and not all of them are going to necessarily pan out like clockwork.

But the thing about technical analysis and trading patterns is that sometimes before you throw the towel in and completely give up on a trade or thesis, you have to allow for a margin of error.
Just because something did not occur exactly in textbook fashion does not necessarily mean you’re going to be proven wrong.

When we study technical analysis, it’s a finite study.  But if you’ve been trading and investing using this approach in the real world, you know it’s more like an art form, and the better painter you are, the finer the art work you can create.

Of course, you can also be proven wrong, which happens probably more times than one cares to think.  But how we counteract that problem is by simply using a risk management process for those times where you’re ultimately proven to be wrong.  And then you move on.

Last week when I penned the follow-up article that gold may be setting up for a fifth wave to possibly $1500, I recommended bullish trades on gold and gold mining stocks as the price of gold was pulling back towards $1350, which I anticipated would be an area that would soon bring support and the resumption in the intermediate-term bullish pattern.

If you refer back to that article, I shared with you a very important “market tell” that I learned years back that great technical analysis traders pay close attention to.

You can go back and revisit the statement in the entire context of the article, but I’ll quickly pull the lines:

… the $1350 level is technically important for the wave cycle, and if any forthcoming weakness should happen to drop the price action meaningfully below, then the selling pressure will need to be quickly exhausted and a prompt return to $1350 and beyond would need to transpire.

“Sometimes, a tricky shake-out reversal is exactly what’s needed to clear the way for the next big move.”                                

That revelation is indeed timeless and may even be more relevant in the modern trading landscape because of the advent of advanced computer technology and high frequency trading.

Yesterday, gold broke below $1300 and hit a $1291 intraday low.

But after the Fed policy statement, gold exploded and was trading $75 higher off those lows to around $1365, creating an “outside day” bullish reversal. 

Not only was it a big move, but it also promptly recaptured the key $1350 level.

There’s no doubt that the gold shorts got “surprised” too, and a big part of yesterday’s move was attributed to covering those bearish positions.

That means that the next several sessions will ultimately prove quite telling, as the $1350 level looks like the battleground level in the price of gold.

Will yesterday’s technical reversal complete the fifth wave?

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