by Tyler Craig | July 24, 2013 12:22 pm
Gold is fast approaching a critical juncture — an area sure to incite a fierce game of tug-of-war between recently emboldened bulls and still-resolute bears.
Click to Enlarge The tarnished yellow metal’s nascent attempt at resurrecting itself has been aided by a weakening U.S. dollar. As shown in the accompanying chart overlaying the greenback with gold, the turnabout kicked off once the buck topped out in early July (red arrow).
The degree to which these two assets are correlated certainly fluctuates, but by and large, they tend to always return to some type of negative relationship (see correlation study in chart).
Said another way, in the playground of finance, they sit on opposite sides of the teeter-totter.
Click to Enlarge Interestingly, despite clawing its way back to $1,350, gold remains firmly entrenched in a long-term downtrend. In essence, the oversold bounce after its plunge to $1,179 was a gimme — the easy part of the rebound trade. Now, the mettle of the beleaguered metal will truly be tested.
Given the significance the $1,350 level held as support before finally breaking, one would expect it to perhaps act as a brick wall, stymieing the current advance. The principle of old support becoming new resistance is surely in play here.
And yet, perhaps the current surge will succeed where so many others failed.
Since the most painful stage of gold’s downfall kicked off earlier this year, every attempt to ascend from the abyss and reclaim previously broken support levels has failed. Sure, gold has rebounded from time to time, but never enough to interrupt the series of lower pivot highs and lows that has been in place.
And so, bulls and bears alike will be watching the $1,350 zone with rapt attention. If gold is able to break aggressively above this level, it would mark a decisive change in character for the beaten-down commodity since its downward spiral started picking up steam last October.
In light of the $150-plus bounce and the mega-overhead resistance level, this might not be a bad spot for those who exploited part of the recent rise in gold to tighten stops or take partial profits. Nor is it a bad location for those expecting a resumption in the longer-term downtrend to enter bearish plays.
The beauty of the current setup is that it offers the ability for a tight stop-loss. If gold successfully breaks above the $1,350-$1,360 zone, simply exit your bearish positions to minimize the loss. On the reward side, gold has plenty of room to fall if it ends up revisiting its prior lows of $1,179.
One simple bear play to consider is buying puts on the SPDR Gold Shares (GLD) once gold confirms it’s starting to turn lower again.
The October 129 puts should do the trick — right now they can be purchased around $5.10. As with all long put trades, your max risk is limited to the initial debit paid, and the max reward is unlimited until the underlying falls to zero.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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