Elliott Wave International circulated a report to subscribers on Friday in which Bob Prechter, Founder and President of the firm, advocates shorting gold at current levels with a $1790 stop (to be lowered to $1765 if prices breach $1700). I agree that on a near-term basis, the trend is extended and due for a correction, but my perspective is that whatever damage the yellow metal sustains over the near-term is likely only the interruption of the larger degree uptrend, rather than its end.

My outlook is based on several observations. For one, while short-term momentum is overbought and appears to have peaked this past Thursday, intermediate-term momentum continues to improve from oversold. In fact, weekly momentum only bottomed earlier this month. As a result, this indicator is likely to improve for several months. Exhibit 2 below demonstrates these conditions graphically.

Exhibit 2: Momentum for Gold

Prechter’s Interim Report referenced extremely bullish sentiment for gold, as measured by the Daily Sentiment Index. Jake Bernstein, developer of the DSI, indicates that this tool is a short-term indicator. A look at longer-lead sentiment gauges for gold suggests that intermediate-term sentiment is still neutral – and probably closer to oversold than overbought in most cases. Again, the implication being that the bigger trend may not (yet) be at risk. Refer to Exhibits 3 through 5 for a pictorial view of sentiment over the intermediate- to longer-term.

Exhibit 3: Public Opinion
Exhibit 4: Commitment of Traders
Exhibit 5: Hulbert Sentiment

Moreover, the Morgan Stanley Metals Analysts Team made the case in late December that the decline in gold prices was driven, at least in part, by bank funding stress. They hypothesized that central bank efforts to make access to US Dollar funding more accessible, and ultimately the Fed’s engagement in QE3 would ease downward pressure on gold prices (MS Economists expect QE3 by Spring). In harmony with this hypothesis, when measures of interbank stress, such as the TED spread and the LIBOR-OIS spread, began to improve in late December gold prices rallied. Further, Fed Chief, Ben Bernanke’s January 25th press conference, which many pundits interpreted as priming the pump for QE3 or some other form of Fed activism, corresponded with the start of another leg up for gold prices.

Thus, there seem to be several technical and fundamental buttresses for the longer-term upward trend in gold prices. I do not have a strong view of exactly how much longer strength can persist, however, I am inclined to give the decade-long rally the benefit of the doubt into Q2. Still though, short-term momentum, sentiment and even seasonality suggest that some manner of pause is in order (Exhibit 6 demonstrates that February has historically been a bad month for gold).

Exhibit 6: Seasonality

For speculators inclined to put on shorts right now per Bob Prechter’s advice, I would agree that, from a trading perspective, there may be valuable information contained in his Interim Reports. To wit, in 2011 Prechter issued IR’s calling for a short S&P 500 positions three times, and short gold position three times. In each case, his call came within days of the absolute top. However, not all trades were profitable (in fairness, the summer trades were quite profitable by any accounting, as most markets tumbled considerably, so by extension, the year was profitable in aggregate). Nonetheless, this observation leads to my final point: I suggest that traders consider going their own way in crafting an exit strategy. It seems to me that Prechter’s bearish big picture perspective greatly influences the liberal stop levels he prescribes. One might be better served by coupling Prechter’s top calls with an alternate system for picking bottoms.

Trade nimble and stay safe!