The Secular Winds Be a-Shiftin’ for Gold

by Tyler Craig | March 8, 2013 8:41 am

The secular bull market for gold that began in the early 2000s is facing some serious headwinds. The precious metal has fallen just less than 20% since peaking in late 2011 at $1,920 and is currently on a five-month losing streak.

While gold bugs still cling to the hope that a renewed surge in the yellow metal is looming on the horizon, multiple technical and intermarket signals have arisen that paint a decisively more bearish picture.

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First, consider the continued erosion in long-term momentum indicators viewed on a monthly chart of gold. In response to the lackluster, sideways price action in gold over the past two years, the MACD indicator has plummeted to levels not seen since 2002. Even the most ardent bulls should find the magnitude of momentum’s downturn a bit disconcerting.

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Second, the performance of the Market Vectors Gold Miners ETF (NYSE:GDX[1]) has been utterly atrocious of late. With the latest downturn in GDX breaking the $40 level, a multiyear rounded top was completed, which could act as major resistance going forward. As shown in the accompanying chart, gold miners have a very strong positive correlation with gold. Continued selling pressure in the space should make it all the more difficult for gold to stage a lasting advance.

Third, the resurgence of the stock market might dampen the appeal of gold for investors. Let’s not forget the bull market in gold commenced in 2000, right when the stock market peaked. Amid a secular bear market for stocks over the ensuing decade, disenchanted investors flocked to gold, driving its price into the stratosphere. With multiple stock indices breaking out to new all-time highs over the past month, perhaps the era of gold outperformance is coming to a close.

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One way to view the performance of stocks versus gold is using the Dow/Gold ratio. The ratio is plotted as a line which rises when stocks outperform gold and falls when gold outperforms stocks. As shown in the accompanying chart, the ratio began to trend lower in 2000 as the mega-bull market in gold kicked off. Although the ratio remains below the multiyear downtrend line (red line in chart), it has rebounded considerably off its 2011 lows breaking above a short-term resistance level (blue line). A continued rise in the ratio would act as further evidence that gold has been dethroned.

To exploit a continued decline in gold, you could purchase bear put spreads on the SPDR Gold Shares (NYSE:GLD[2]). Since we’re talking about a longer-term trend change, let’s use January 2014 options to allow adequate time for the reversal to occur.

Buy the Jan 2014 150 put and sell the Jan 2014 140 put for a net debit of $3.50 or better. The max risk is limited to the initial $3.50 paid at trade entry and will be lost if GLD remains above $150 by expiration. The max reward is limited to the distance between strikes minus the net debit, or $6.50. To capture the entire profit, GLD would need to fall below $140 by expiration.

In timing the entry to the spread, you could wait until GLD breaks below the $150 support zone to confirm the trend reversal.

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

  1. GDX:
  2. GLD:

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