Gold Higher This Morning, But Is It Due For A Pullback?

Gold futures are higher this morning on strong investment demand and an upturn in jewelry demand. Some of the largest hedge fund managers, including John Paulson, have taken advantage of the relatively low price of the metal over the past month and a half to add to their holdings, with the mindset that the stock market rally that began in March may, in fact, be a sucker’s rally. The reason for this opinion stems from the fact that the rally has been largely driven by banking stocks in the wake of a possible bottoming of the housing market, rather than productivity and improved economic outlook.

Physical holdings of the SPDR Gold Trust (GLD) remain at record levels, but investment has leveled off in recent weeks as a result of the stock market rally. Johnson Matthey, a chemical company that refines precious metals, stated that they see jewelry demand rebounding in 2009. The pullback in prices from February highs is cited as a reason for the improved jewelry outlook. Gold has been quiet for the most part due to the spotlight being focused on equities, energies and base metals. The price of the precious metal will, in all likelihood, continue to take its cue from outside markets — such as the equity and foreign exchange markets — unless there is a material increase in inflationary pressure.

The movement of equity prices of late has been somewhat neutral for precious metal prices, as every decline in equities is greeted by a higher US dollar, counterbalancing what would normally be a bullish influence for Gold. Given the sizable long position in the metal, price risk remains to the downside, and patient traders may be waiting on the sidelines for a pullback.

Trading Ideas

Given the bearish technicals and neutral fundamentals, some traders may opt to get into a conservative bearish strategy, such as buying a put option. Bearish traders might choose to purchase the July 890 put for 10.00, or $1.000, hoping for a pullback to the 850 level. The risk would be the initial investment for the possibility of 30.00, or a $3,000 return if the price of August Gold falls to 850.00 by the June 25th expiration date. Since this would require a sizable move over a relatively short timeframe, traders could close the position early if the premium on the option contract were to double in value to 20.00, or $2,000.

Technicals

The June Gold chart shows prices steadily climbing from April lows, but the slow, grinding move higher may be an indication of a downward bias. The daily chart shows what may be seen as a mundane indication of a near-bottom, but a look at the weekly chart shows a possible bearish pennant. This suggests that prices could pull back to the 50 percent retracement from October lows at 845.00. Also, momentum and RSI are both moving lower since the last week of April, despite the increase in prices over that same period of time. This could be an indication that prices are due for a rather sharp pullback.

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