Gold’s Rebound Is Likely to Fizzle

by Tyler Craig | February 27, 2013 8:46 am

Don’t look now, but gold is on a four-day winning streak. The bullish move is a nice change in character from the relentless selling that had pushed the yellow metal down as much as 6.4% this month.

However, before you pull out the pom-poms and don your rally caps, you should know that the current rebound is likely to fail.

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The SPDR Gold Shares (NYSE:GLD[1]) remain firmly entrenched in a downtrend with a falling 50-day moving average. Since peaking in October at $174.07, each rally attempt has been soundly rejected by the bears, eventually giving way to a renewed decline and leading to new lows.

While the current run might continue for a few days yet, a cluster of potential resistance levels loom overhead:

  1. First, the prior support level around $159 could stymie the advance by becoming a new resistance level.
  2. Second, the $159 zone also is a 38.2% retracement of the entire downtrend that began in October. Fans of Fibonacci retracements contend that the 38.2% level often is an area where counter-trend moves terminate.
  3. Finally, the declining 50-day moving average has been consistent resistance all throughout the current downtrend.

Upon completion of the current bounce, you could sell out-of-the-money April call spreads to profit from a continuation of the downtrend. Short vertical call spreads also offer the ability to profit, even if GLD moves sideways over the coming month. To enter the trade, sell the April 163 call and buy the 168 call for 65 cents or better. Consider the trade a bet that GLD fails to rise to $163 by April expiration.

The max profit is limited to the initial premium received and will be captured as long as GLD remains below $163. The max loss is limited to the distance between strikes minus the net credit, or $4.35. To minimize the loss, consider exiting the trade if GLD rises above the short call strike ($163).

In timing the entry, I suggest waiting for the current rally in GLD to falter. If it continues higher for another few days, you should be able to sell the call spread for an even better credit.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. GLD:

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