There are three basic aspects of the Elliot Wave Theory - wave pattern, ratio and time (inthat order of importance). Elliott claims that the Stock market follows a repetitiverhythm of a five-wave advance followed by a three-wave decline. The chart above shows onecomplete cycle. Wave one, three and five go with the main trend and are called impulsivewaves. Wave two and four are corrective waves. After a five-wave advance has beencompleted, a three-wave correction begins, subdivided in an A-B-C structure. After that, anew five-wave advance can start.
Now what is interesting is that you can use the Elliot Wave theory to forecast theduration of market moves. I consider wave one the first phase of a bull market andwave two a consolidation period leading to wave three or phase two of the bull market.
According to Elliot Wave Theory, wave two retraces .618 of the move of wave one while wavethree consists of 1.618 of wave one. Wave five is either 1.1418 or .382 of the totalmove of waves one through three.
Applying Elliot Wave Theory to Gold
So in getting back to the stock market, the XAU made a bottom in 2000 at 41.61. Itthen began wave one which ended in 2003 at XAU 113.41
According to Elliot Wave Theory, the XAU should have retraced up to .618 of the move from41.61 to 113.41. Such a retracement would have brought the XAU down to69.l376. The XAU made a wave two bottom at 76.79, which is pretty close.
Now we should be beginning wave three of the Elliot Wave sequence, which should add 1.618times wave one points to the XAU. In other words wave three should add 116.18 pointsto the XAU (71.81 X 1.618). That would mean that wave three will end with the XAU at192.97(116.18 + 76.79).
What is exciting for gold investors is that phase two of a bull market is the mostprofitable phase to be in. It is the longest and biggest cycle of a bullmarket. Wave three is also the most profitable wave in the Elliot Wave sequence.
At the moment, the XAU is consolidating below its key three year resistance level. The rally since May in gold stocks has been fun to be a part of, but the real move hasn'teven begun yet. This consolidation period is the perfect time to either add on toyour gold stock position or initiate one if you don't have one yet. We aren't quiteat that time yet. The XAU appears to be consolidating below the 110-113 area justlike it did below 95 back in June. We'll get an entry point soon.
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Enjoy, C.C.
