Managing The Risks Of Gold’s Bullish Trend

Lately, there has been plenty of talk about gold and a growing consensus that favors bullish fundamentals. Here’s my take on gold based upon the Spyder Gold Trust ETF (GLD) and its most recent wave, i.e. from 1-15-09 bottom @ 78.87 to 1-26-09 top @ 90.19.

First, to keep things in proper perspective, the GLD has already appreciated 27% since Nov-12-2008. Also, let us not forget that central banks have a perverted sense of humor and plenty of “funny money” and other diversionary tricks up their sleeves to defer the inevitable arrival of inflation. With this as our background, I will jump right into my strategic analysis for trading or investing in gold.

GLD hit resistance @ 90.19, has retreated and appears headed to test support @ 86.50 with the possibility of also filling a minor gap @ 85 level.

If support holds, the natural inclination is to buy (entry @ 86.75 with a stop loss @ 84.12 for -3% maximum loss). Assuming one is playing this trade for an exit @ its most recent resistance, i.e. @ 90.19, the risk to reward ratio is only @ 1.33. In a fear-driven market environment, I am strongly inclined to pass on these odds (even with beer goggles).

Ideally, a trade with a minimum risk to reward ratio @ 3 or 4 is much more seductive, even in interesting times like these. However, to find the ideal opportunity, one needs to be patient and think counter-intuitive to the buy low and sell high paradigm. Hypothetically (I only say “hypothetically” because I have been long the GLD @ 74.85 since Oct-29-2008.), I would wait for the GLD to break above its resistance @ 90.19 and buy @ $90.50. This would confirm that there is additional demand and fresh support at this level.

Here is where the trade can get a little tricky. There is some resistance @ 92 level and one should probably anticipate a minor pullback and retest of the newly established level of support @ 90 area. However, if support is violated, I am willing to accept a stop loss @ 89 for a -1.5% maximum loss of capital. In the majority of instances when support fails the “retest”, this signals a false breakout.

Now let’s get to the good part. If the breakout is legitimate, then the GLD should run to @ 97.50 area, which is its next level of major resistance and also where I would definitely be inclined to book some short-term profits or at least hedge my position with long puts and/or short calls. Under this scenario, this trade presents a much more attractive risk to reward ratio @ 5.24.

Gold certainly has both technical and fundamental positives going for it. The short, intermediate, and long term are all trending upward while the monetary policies of global central banks reflect a desperate willingness to accept future inflation to avert the immediate threat of deflation. Another tail wind, also aiding gold’s bullish movement, is the recent weakness and apparent correction in the U.S. Dollar Index.

In summary, the example of the above trading strategy is an opinion on how to play gold for those who are risk averse and can ill afford to lose more capital. Otherwise, for those turned on by a fundamentally bullish or bearish bias towards the precious metal, assume the position (pun intended) and enjoy the ride along with all its ups and downs. Yeah Baby!!!

*Note that the purpose of this report is not to provide specific recommendations, but instead serve as a starting point for investment ideas. It is strongly recommended that you do your own homework and due diligence research analysis.

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