Interactive Investor

Chart of the week: A share that keeps giving

23rd January 2017 12:04

John Burford from interactive investor

Another great run in Fresnillo - but is it about over?

Long-time readers will know that I have been covering silver miner Fresnillo for well over a year when it was on few people's radar. I would venture to say that most private investors had never even heard of it, despite its inclusion in the FTSE 100 index.

Of course, the reason it was well under the radar is that it was in a well-established bear trend along with the metal itself. Bear markets attract few investors. But trends do change - and that is when I am on high alert. In fact, last summer saw the highest level of trader/investor pessimism towards the metal in history. The mainstream media was full of negative news and opinion.

The counter-trend Fed rate hike in December 2015 was considered the death-knell for precious metals. There is a myth that higher interest rates always pressure the metals, but a simple survey of the historical record will show that sometimes they do and sometimes they don't - there is no fixed pattern. All the bears were doing is rationalising their already bearish feelings.

They believed the bear trend would continue indefinitely - the default stance of the vast majority. Gold was projected to trade at under the $1,000 level. It didn't, of course.

And one hedge fund manager summed up the herd's bearish mentality with the belief that further Fed rate hikes were a definite probability. Yes, of course they were. But even if that panned out, would that imply lower metal prices?

My answer is this: if enough market participants believed it, it would not happen.

Perverse, isn't it? But that is the way markets operate - they are driven from high optimism at tops to high pessimism at bottoms. And the majority get caught out at just the wrong time (especially trend-following hedge funds) when trends change.

With Fresnillo's decline off the £20 highs, where we took major profits, the market declined erratically to a low of £10.50 in December which is the area of the Fibonacci 62% correction of the entire bull move off the 2015 lows.

Here is the weekly chart showing the lovely hit on the Fibonacci 62% support zone:

Remember, in a strong trend, corrections are most often turned back at this Fibonacci level. And note that the form of the correction is an A-B-C three-wave affair, which denotes corrective behaviour.

Putting all of this together I concluded that the market was preparing for another leg up from the December lows and another long trade was advised. There was a natural point to enter stop-loss orders just below the C wave low if wrong.

So now we have seen a strong rally off the £10.50 lows to the recent £14.50 level - a gain of about 40%. Nice.

But is that it, or is there more? Do I have any reason to take any profits yet?

For clues, here is the daily chart:

I have set my Fibonacci levels on the A-B-C wave down and note the rally has carried right to the Fibonacci 38% resistance level (yellow bar) in virtually a straight line up, which places the very short-term position as over-bought.

But what sticks out on the chart for me is the breakaway gap on the way down last November. Remember, gaps very often act as magnets that eventually draw prices back to them. This one should conform.

My best guess is that the current rally is wave 1 of what should turn out to be a five-wave up pattern. If so, I expect wave 2 to start soon and then a big rally in wave 3 up.

There are many ways to trade this setup. Long-term traders/investors will be holding positions expecting more upside after a pull-back.

Short-term traders will be taking at least some profits and look to reinstate on a dip.

So, before you start trading, I suggest you need to focus on which time frame you wish to operate in for each market you follow. That way, you will receive fewer surprises - and I hate negative surprises!

 This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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