A Warning Signal Every Gold Trader Should Watch

08/30/2010 11:18 am EST

Focus: COMMODITIES

Yes, gold has been in a ten-year primary bull market. Yes, gold has already quintupled in price. Yes, gold usually makes a nice run higher during the fall. Yes, some market analysts are predicting that gold will run to $2,000, $3,000, or even $5,000 an ounce. Yes, every other TV commercial on the Glen Beck show is trying to push a bag of Kruggerands or maple leafs into your grabby little hands—and for your own good, of course.


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Now that we’ve gotten all of that important stuff out of the way, may I share with you a weekly chart of the continuous Comex gold futures contract—one that depicts a very accurate “early warning” Commitment of Traders (COT) net futures positions graphic as well? Without getting too boring or technical here, the bottom line is this:

  1. When the spreads between the large speculator and commercial net gold futures positions get toward historically wide levels (like we’ve seen recently), it can be an early warning of an impending selloff

  2. When you see condition number one occur along with a negative divergence in the large speculator net futures positions (top line of the COT plot in lower window), there is even more indication of a possible selloff in gold

  3. When you see both conditions appear along with a bullish divergence in the commercial net futures positions (bottom line of the COT plot), well, then you’ve really been read the gold market’s equivalent of the riot act, meaning of course that you need to closely guard any existing open long gold futures positions, if not actually sell at least a portion (if not all) of your current long positions

For those who are on the sidelines, just itching to get a piece of the “sure-thing” seasonal rally that usually takes gold higher during the last months of the calendar year, this is also a friendly reminder from the gold market that it might be much safer to put on new long gold positions only after a confirmed breakout and subsequent retest of the June 2010 high near $1,269.00.

Now, for all we know, maybe the recent $110 pullback in gold (the July selloff) was the selloff that the COT configuration was predicting, but it would still be a good idea to keep a close eye on any open long gold contracts you’ve committed to, because if this latest surge higher is just a tiny rally before a larger corrective wave down commences, you don’t want to be caught in the carnage that could conceivably ensue.

Play it safe. Tighten stops, sell into current strength, and wait for a fresh long setup on the north side of $1,269—assuming gold actually makes it back to that lofty level in the first place.

By Donald Pendergast of ChartW59.com

Donald Pendergast has been trading and investing since 1979. His Web site address is www.chartw59.com

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