Will Gold Continue To Be Worth Its Weight?

After an impressive $300 plus rally since the end of October, Gold futures have taken a breather, falling into a consolidation phase as traders attempt to determine the direction of its next move. Just like the Oil market I spoke of the past Thursday, both Gold bulls and bears have fairly convincing arguments that their positions are correct.

Those favoring a bullish position in Gold are nearly always concerned about inflation, and the massive world-wide stimulus packages being floated out into the market to help combat the global recession we now face certainly provides potential fuel for rocketing inflation once the economy recovers.

Talk by both Russia and China about the need to form a new international “super currency basket” to move away from the U.S. Dollar as the world’s reserve currency has also sparked interest in Gold as this “basket” would be created with a diversified group of the major world currencies as well as Gold. Of course, Gold’s role as a “store of safety” especially during turbulent economic times, will always find a bid from cautious investors looking for diversification from equities and bonds.

Those traders who like the red side of their trading cards, the” perennial bears” in Gold point out the comments from the recent G20 meeting last week in London, requesting the International Monetary Fund to begin to sell some of its vast Gold holdings, which total about 103.4 million ounces as of February 2009, to help fund monetary aid to lower income countries.

The IMF is believed to be the third largest holder of Gold, and any planned sales could send a negative signal to the market. Gold imports by India, the world’s largest buyers of Gold, have been flat, with demand falling as buyers await lower prices. The recent modest recovery in equity prices have some investors believing the worst may be over or nearly over for the economy and are moving some funds out of more “safe haven” investments like Gold and back into the stock market.

Though it is still too soon to tell which side will gain the upper hand in the Gold market, there are some options strategies that traders may wish to investigate if they believe a large move is in store for Gold futures once the consolidation phase ends but are unsure as to the direction of the move. Buying Gold option strangles is one such strategy. A long strangle consist of buying a call option and buying a put option in the same commodity and contract month but at different strike prices. A large move in the underlying futures and an increase in implied volatility will help this position and time decay will work against this position. June Gold is currently trading right around the $900 level as of this writing and an example of a long strangle trade would be buying the June Gold 940 call and buying the June Gold 860 put.

The total cost of this trade, as of this writing is $5,130 per contract and will be profitable at expiration if June Gold is trading above $991.30 or below $808.70. The maximum risk is the total amount paid for the position. Due to the relatively large cost of the position, many traders would exit the position before expiration if a sharp move and increase in volatility occurs quickly or there is less than 2 weeks before expiration to avoid the increasing affects of time decay on the position.

Technicals

Looking at the daily chart for June Gold, we notice the market making lower highs and higher lows the past two months. The moving averages are mixed with the 20-day moving average turning bearish but the longer term 100 day MA still favoring the bulls. Momentum as measured by the 14-day RSI has turned neutral to bearish with a current reading of 42.30. Support is seen at the January 29th lows of 877.40, with resistance found at the March 20th highs of $970.00.

Traders should watch for a close above resistance or below support on higher than average volume as a potential signal to the direction of the next major move in the market. Mike Zarembski, Senior Commodity Analyst

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