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The euphoria that surrounded gold two years ago made gold bugs wealthy as lofty predictions and price targets sent traders in a frenzy trying to play catch-up, but its decline over the last two years has shown us how quickly momentum can shift. And the accelerated drop in prices this year has been triggered by news of Fed tapering coupled with a stronger American dollar.
Last week, an independent author for Marketwatch.com provided technical analysis informing traders that a breakdown on the uptrend line would result in massive selling. Two different continuation patterns were crossing paths giving reason that the breakdown was days away. On Tuesday, that trend-line was breached with many indicators going bearish such as the DMI and RSI, as seen below. Gold is down about 4 per cent since. Based on our calculations, the selling pressure could mount to an additional 3 per cent drop with the SPDR Gold Trust (GLD), a US-priced exchange-traded fund that tracks the spot price of gold, could drop to the $124 price, which is the last level of support
How to read the charts
The price chart's purple trend lines were rising upwards until September 10, when the price dips below it. A general rule of thumb is to allow three days for any signal to be confirmed since signals of change can be false or to find additional evidence. Today is the third day, and gold prices have not mounted any comeback and has pushed down to the Bollinger Bands, a mathematical band creating a range used to determine overbought or oversold conditions. We see that gold is now oversold, suggesting a short-term rise or end to declines, but its breach also means that the bands will start moving downward and create conditions for more falling prices.
In the lower indicators, the MACD (Moving Average Convergence/Divergence) confirmed gold is bearish as well, pointing to a second potential signal. MarketWatch uses simple to use colours and when the "red line" rises above the "blue line," it is basically saying that negative conditions trump positive conditions. This is consistent in all their indicators. The black divergence curve also went negative at the same time as the cross and is another clue that the trend was confirmed.
In the DMI (Directional Movement Index), we see the exact same colours crossing. The lines essentially represent the battle between the bulls vs. the bears. And a declining "blue line" means that bulls have lost strength. A crossover means that sentiment has shifted, in this case bullish to bearish.
So what do I predict? Gold will have declines into October, but for two days, we should not see anything. Wait until next week to create a position, either short, go long a bear-ETF, buy the puts or a credit call spread. Any of these trades should be profitable if executed properly along with a decline in gold prices.
Gold continues to soar to new heights. June '10 contracts are currently trading at $1,245 in mid-afternoon trading on May 12. The last time gold traded at levels above $1200 was back in December 2009. Concerns in inflation in China and flight to safety amidst European fears have contributed to the current rise. But those who bought gold stocks back in December have not seen a comparable return, and many gold stocks are down 20 per cent since the high.
Purchasing commodity stocks to participate in a commodity's rise is a common error retail investors make. The main reason is that stocks are priced by company earnings, results, and management. Tying in the price of gold with a stock is fallacious reasoning. Theoretically, gold could continue to break new records everyday but if a gold mining company has hedged revenues or incurred large expenses, one would expect that stock to under perform.
So how can you participate in gold properly? The easiest way is to purchase the bullion itself, but at a cost of $1,245, one ounce isn't as cheap as it used to be. Secondly, your broker will often charge a spread on the purchase and sale, commission, and a safekeeping fee of a few pennies a month.
If this option is not viable, especially if you are a small investor with less than $10,000 to start with, consider purchasing gold exchange-traded funds (ETFs). ETFs are managed by large firms, such as Barclay's or Standard & Poors and mimic the movement of gold as close as possible. The most commonly traded and largest holder of gold is the S&P Gold Index [GLD:NYSE].
GLD is 10:1 against the real price of gold. GLD is currently at $122.07 versus $1,245.00. GLD is the largest holder of gold because every time you buy GLD shares, the fund must go out and purchase the gold. The fund has been on the market for over 5 years and its liquidity and simplicity has made it a very popular product.
Another added benefit is that it is options eligible, so you can use it to protect your recent gains, or speculate on the options at a much lower cost.
If you really wanted to have gold in your account, as is highly recommended by professionals, this is the cheapest and most efficient route. Make sure that it is in line with your investment objective and suitable for your account.
I purchased Kinross Gold several years ago, when gold was much lower, and my shares have not risen with the price of the commodity. If I could go back, I would have purchased the GLD shares instead, so take it from me. ETFs on commodities is a much better choice than picking an individual stock.
