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Despite some calling for an explosive summer rally in
gold, prices fell again this week on the back of easing concerns over Greek
sovereign debt as the Greek parliament successfully passed the austerity
legislation required to access additional bailout funds. This was due to the
erosion of what we call gold's "Eurozone Debt Crisis Premium" and,
as explained in our article last week; gold prices were not likely
to rally in any sustainable manner. However the question is where are gold
prices heading from now and how should one go about trading or investing in
this environment.
The
summer doldrums are in full flow, so seasonal weakness is to be expected.
However it is during this period that the most money can be made, since it
can be used to establish positions in anticipation of the next major move in
gold. As the great Chinese General Sun Tzu said "Every battle is won,
before it is ever fought". The big money in the last major move
wasn't really made as gold hit $1425 in November or $1550 in April, it was made during the summer weakness of July and August
when gold traded at less than $1200. The trades that are placed and
investments that are made over this period can bring fantastic returns when
the more exciting time of year comes around.
Having
fallen roughly 6% from its highs around $1577, we now think that the downside
for gold is limited. Technically speaking we are seeing some important
support lines and the 150 day moving average converge around $1445 and we
therefore think it is unlikely that gold prices will fall past this level.
In
addition to this, the Relative Strength Index for gold currently stands at
36.76. Historically speaking, if the RSI falls to 30 it is a screaming buy
signal. We aren't seeing that screaming buy signal just let, but it could be
just around the corner.
Looking
to the fundamentals that drive gold, we think fears over the Eurozone crisis
will continue to subside (despite the longer term underlying problems
remaining unresolved). In additional to this, money markets are now fully
pricing in a hike by the ECB in July and the December Euribor
interest rate futures indicates that there is roughly a 70% chance the ECB
will hike again in 2011. These two factors signal to us that the Euro is
likely to go higher, the US dollar lower and gold priced in dollars to
increase. Keep in mind that the ECB's main objective is price stability, ie to control inflation, as opposed to the Federal
Reserve's dual mandate to strive for full employment as well. Therefore the
ECB can be considered more likely to hike relative to the Fed, leading to
some possible interest rate differential induced strength in the Euro against
the Greenback.
Taking
a technical look at the USD Index, the 76 level appears to be offering
significant resistance. This is also the same level that the USD bounced off
in November 2010.
Whilst
some choppy lateral motion is possible in the short term, we think the dollar
will endure a serious decline in the medium to long term, coupled with the
next major rally in gold prices.
Another
factor being discussed that could possibly cause a large move higher in gold
prices is that of a possible QE3. At present we do not see much likelihood of
a QE3 program, at least not in the same nature as the previous quantitative
easing programs. However we do think US monetary policy will continue to be
supportive of higher gold prices, with the Fed keeping rates at zero and the
TIPS yielding negative rates for multiple maturities (Please see our previous
article: The Key Relationship between US Real Rates and Gold
Prices).
Equally
as important as devising what the move in gold will be and when it will occur
is how one trades the move. This is a point that is often not given enough
emphasis. As we have stated before, we think options are the best way to
trade these moves. No other instrument can offer opportunities that options
offer. Using options one can create a position that exactly matches one's
view on the market. Suppose one agreed with the views expressed above, that
gold would not fall significantly. Using options one can be rewarded for the
exact scenario. Gold stocks, futures or ETFs cannot offer that flexibility
or adaptability, they simply offer the investor the
chance to bet up or down.
It
is for these reasons that options trading offers up many attractive
opportunities from a risk-reward viewpoint. We specialise
in indentifying these opportunities and executing
trades to take advantage of them. We have executed
81 trades since inception, with 78 closed at a profit and an average
return of 40.41% per trade including losses. Our model portfolio is up 338%
since inception but over the same period gold is up only 55%, the 200%
leveraged gold ETN (DGP) is up 115% and the HUI gold stocks index is up 40%.
In
conclusion, if one has a long term bullish view on gold then this is the
summer shopping season so try not to get too tied up in the day to day market
action. Keep the big picture in mind. This gold bull has a while to run yet.
We are not perma-bulls and do not consider
ourselves "gold bugs", we simply see market conditions as bullish
for gold in the longer term.
Sam Kirtley
SKkoptionstrading
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