If You Have to Trade Gold, Know This

by James Brumley | October 9, 2013 9:29 am

If there’s one thing the past five years should have taught us, it’s that gold is priced by speculation and philosophy as much as it’s priced by its so-called fundamentals. That complexity hasn’t prevented plenty of experts — as well as amateurs — from spouting off their opinions about where gold is headed. But, at the end of the day, only the folks who understand that trading gold is an art as well as a science have survived gold mania relatively unscathed.

So what does that mean for gold right now?

The Science

It’s not an exhaustive list, but some of the factors considered by professional forecasters when looking ahead for gold include …

Of course, there’s nothing bearing down on gold right now as much as the prospective end to the Federal Reserve’s end to its bond-buying program … aka “the taper.” With the ongoing rebound in the economy, the Fed has little choice but to whittle down its monthly injection of $85 billion into the economy.

That’s what Goldman Sachs’ head of commodities research Jeffrey Currie said at the Commodities Week conference[1] earlier this week, anyway. He and Credit Suisse’s commodities guru Ric Deverell both agree that the coming year’s best bet is shorting (or betting against) gold.

His catalyst for the proverbial beginning of the end for gold will be the inevitable raising of the debt ceiling by the Oct. 17 deadline, though the foundation for a sizable demise of gold prices will ultimately be fueled by a strong economy. Currie’s exact words:

“Once we get past this stalemate in Washington, precious metals are a slam dunk sell at that point … You have to argue that with significant recovery in the U.S., tapering of QE should put downward pressure on gold prices.”

When it’s all said and done, he and Goldman Sachs are looking for gold to fall to $1,050 per ounce at some point in 2013, off by 20% from the current price of $1,324.

The rationale makes sense. The perception of how well the economy is doing, however, might be a little too enthusiastic. And, perhaps more than anything, Currie’s call seems to ignore a couple of other key factors — like the fact that the dollar is currently weakening, and that interest rates are on rise.

Chart image from TradeStation

As more evidence to that end, it was only a few weeks ago that Ben Bernanke shocked the world by deciding he would put off the tapering plans until further notice; his Congressional testimony fully indicated he was willing to maintaining the $85 billion per month QE efforts for months, if need be.

If the economy was good enough to deflate gold, it certainly would be good enough quell the Fed’s stimulation efforts.

The Art

Even if Currie’s outlook regarding the debt limit and the broad economy is right, there’s still another challenge for the bearish call on gold — investors (retail as well as institutional) would have to believe it and (metaphorically speaking) buy into it. But based on the chart’s action of late, the market might have already collectively drawn its line in the sand at a level much higher than $1,050.

Charts often are deemed to be a log of history, and to a great degree that’s a fair assessment. Just for the sake of discussion, though, consider the possibility that a chart is also a log of the market’s ever-changing opinion based on all the information available up to that point in time. And because opinions aren’t always rooted in facts, charts can disconnect from the underlying fundamentals from time to time.

For an obscure metal like rhodium or a microcap stock that doesn’t actually make anything yet, information might be scarce, and their charts might not reflect any meaningful opinion. But, this is gold — the most prolific, most watched and most traded instrument in the world. If the information and plausible outlook exists about it, it is reflected in the chart.

And gold’s chart says the market doesn’t see the worst that Currie sees.

If it did, gold wouldn’t be holding the line above $1,273 now, nor would it be fishing for a bullish bounce. It’s doing both of those things. And even the most likely worst-case scenario from a technical and psychological perspective is still just the June low of $1,190.

Chart image from eSignal

The Bottom Line

So what does a trader do if he or she agrees with Currie’s call, but also appreciates the strength of the counterargument?

First and foremost, know that not all the outlooks for gold are quite as bearish. Merrill Lynch, for instance, expects gold to end at $1,419 per ounce this year, and any slide should only take gold down $1,356 by the end of 2015. The London Bullion Market Association forecasts that gold will reach $1,400 per ounce at some point next year.

These firms aren’t exactly slouches in the gold arena, and have just as much of a shot at being right as Goldman Sachs does.

With proper caveats in place, the way to play Currie’s call might be a conditional one. If and only if gold falls under its current support line at $1,275 should a short — or bearish — trade be entered on the SPDR Gold Shares (GLD[2]). Better still, you could simply buy an inverse gold fund like the PowerShares DB Gold Short ETN (DGZ[3]) and not worry about permission to short a stock in your account. And although it might leave some money on the table, waiting for gold to move below the bigger floor at $1,190 might be a wiser move if you’re waiting to buy the DGZ or short the GLD.

But if there was ever a case for keeping a short leash on a trade, this is it.

While Currie’s bearish case is good, so too are the bullish arguments. And we’ve already seen how gold can stop and turn on a dime in this environment. No matter which direction you’re trading in, not only is a stop-loss a must, but it would be wise to apply a trailing stop, meaning you scoot that protective stop-loss along as your trade makes progress. That way you get out quickly when things turn against you.

However you decide to handle gold’s forecasts though, keep in mind that even the professionals are wrong some of the time — if only because gold’s value is determined by so many constantly moving parts.

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

  1. said at the Commodities Week conference: http://www.bloomberg.com/news/2013-10-08/goldman-s-currie-says-gold-is-slam-dunk-sell-after-shutdown.html
  2. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  3. DGZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=DGZ

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