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Is This a Golden Opportunity to Short Gold?

Is This a Golden Opportunity to Short Gold?
By Simon Maierhofer
August 12, 2011

Gold prices have benefited from the “Black August” performance of the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC).

Yesterday gold reached a new all-time high. With no overhead resistance and only the sky being the limit, it’s difficult to forecast a new price target or identify resistance.

One thing though is obvious. Everyone loves gold. Gold is almost as beloved as silver was in late April. The trading volume for popular gold ETFs like the SPDR Gold Shares (NYSEArca: GLD) and iShares Gold Trust (NYSEArca: IAU) has gone through the roof. It is no wonder that over 90% of gold futures traders are bullish the metal.

The interesting thing is that the bullishness is limited to gold prices and hasn’t really spilled over to gold mining stocks. Year-to-date the SPDR Gold Shares are up 25% while the Market Vectors Gold Miners ETF (NYSEArca: GDX) is down 3%. That’s not healthy.

An Unhealthy Non-Confirmation

I wanted to see just how big the discrepancy between gold prices and gold stocks really is, so I prepared a little chart for Wednesday night’s ETF Profit Strategy Newsletter update.

The chart – which shows the spread between GLD and GDX, along with my thoughts - is pasted below:

“Everyone’s in love with gold, which stirs up my contrarian juices. Gold remains above the upper trend line and momentum is strong. There’s no need to step in front of this freight train. But gold is extremely stretched and trading significantly above its upper Bollinger Band. Any break in the armor could lead to a scary and unexpected decline.

The chart plots the SPDR Gold Trust (GLD) against Gold Miners ETF (GDX). Shares of gold mining stocks have been stale while gold prices are on fire (the red line shows the spread between GLD and GDX). This doesn’t mean prices can’t go any higher but there sure is an unhealthy non-confirmation.

Even though gold is the logical fear trade, price action is also dictated by liquidity. At some point investors will have to sell holdings to pay off debt or answer margin calls. Commonly the most profitable asset is sold first. Gold has been the best performing asset for decades and a liquidity crunch could produce sellers en masse.”

                   

Since Wednesday night’s update, gold prices have dropped 80 points, which isn’t a huge deal, at least not yet.

Trend Line Support

More importantly, gold prices are trading above a trend line that goes back all the way to 2006. As long as prices remain above this trend line, it’s dangerous to bet against rising prices. But once prices drop below, it’s worth taking a shot at shorting the metal with a stop-loss slightly above the trend line.

                    

Another indicator that helps identify a possible breaking point of a momentum based up trend is percentR, a measure of relative strength.

Using percentR, the ETF Profit Strategy Newsletter was able to capture silver’s (NYSEArca: SLV) drop from 43 to 34 at the beginning of May.

After today’s decline gold prices have arrived at a crucial juncture, at least based on percentR trading guideline. In addition, gold is close to the upper trend line.

Odds are that  gold will tell us soon what it intends to do.

The ETF Profit Strategy Newsletter uses complex technical analysis to formulate easy to understand forecasts, recommendations and trading strategies.

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