In the last issue of Commodities Trends (see Correction In The Cards (But Not A Top), May 14, 2006)--at a time when many mainstream analysts were predicting $1,000 gold in short order--I warned you about a coming price correction in the gold market. Today we know gold has corrected with a vengeance: It’s down nearly $100 from the May 12 peak of $732 an ounce.

What did I see then that correctly predicted the recent crash? What to expect now? Let’s first refer back to the May 12 gold chart and my commentary from May 14.

Comex Gold Futures Through May 12

Commodity.com

While gold remains bullish longer term, it may have gotten ahead of itself. Open interest (the total number of outstanding futures contracts) peaked May 3rd and has been declining on the last rally. I’ve often noted that open interest in a bull run will peak about two weeks prior to a top--on that basis we’re about there.

Note how total OI peaked May 3 and was in decline May 4 through May 12. This pattern alerted me to a potential near-term top in the gold market.

In my book Trading Commodities and Financial Futures: A Step by Step Guide to Mastering the Markets (3rd ed.), I outline “Six Profitable Rules for Analyzing Open Interest.” Rule No. 3:

Comex Gold Futures Through May 26

Commodity.com

See the orange line below the price chart? During the past few weeks, OI has collapsed to the
lowest levels of 2006. In other words, all the OI built up during the gold rally has been liquidated. How to interpret this?

To properly analyze movements in open interest, one needs to interpret it in relation to the major trend of the market. I drew the 50-day exponential moving average (green line) on this chart; the 50-day is utilized by many fund mangers. The gold market has just touched--and thus far bounced off of--the green line. On this basis the major trend remains up for gold.

OI is now down to approximately November 2005 level, around the same point where gold broke above $500 for the first time in more than 20 years. That began a $200-per-ounce bull run. This is potentially very bullish for the gold market.

Here’s another way to look at it: When the last of the weak longs has liquidated (and the last of the strong shorts--the “smart money”--have covered their profitable short positions), there’s a lot of room for gold prices to move back up. The next bull run will unfold as OI is being built back up.

As soon as OI and the per-ounce price start to rise again in unison, I look for the next leg up to begin. I think we’re very close to a major new buying opportunity in the gold market. The last leg took gold up about $200 ounce, from about $530 to about $730. Assuming $636 turns out to be the bottom, a similar up move would take gold to more than $800.

OI isn’t the only indicator I use when providing recommendations to Futures Market Forecaster subscribers, but it’s without a doubt one very powerful tool. I’ve watched it for more than 20 years and find it is as useful today as ever.

George Kleinman is editor of Commodities Trends.

© 2006 George Kleinman
Editorial Archive

KCI Communications, Inc.
1750 Old Meadow Road, Suite 301
McLean, VA 22101
703-394-4931 phone  703-905-8100 fax Email

Risk Disclaimer

Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the "Holy Grail." Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.

Hypothetical Performance

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.