Trading Ideas For Gold: Bulls Embrace “Metal Mania”, But For How Long?

Fundamentals

Gold bulls have certainly enjoyed the upper hand lately, as the yellow metal has surged to all-time highs this week. Gold is attracting interest from investors who are concerned about inflation, especially given the weakness in the U.S. Dollar. This weakness has sparked discussions that an alternative to the U.S. Dollar as the “reserve” currency is needed. Although a shifting to a new “reserve” currency is highly unlikely in the near-term, some investors are turning to Gold as an alternative to holding all of one’s wealth in any one currency. Trend-following traders are embracing the long side in Gold futures, as prices have steadily climbed higher, with only” minor” corrections so far this year. Hedge selling by Gold producers has also been curtailed, and several major mining concerns have abandoned their hedge-selling programs, as the sharp rise in Gold prices has made this a costly endeavor. Some investors prefer to invest in Gold producers who do not “hedge” production, which makes these companies more of a “pure play” on the price of Gold. The popularity of numerous Gold ETF’s available has made Gold investing even easier for the average individual. The record high prices for Gold have come at the cost of its demand for use in jewelry, especially in India, who is the world’s largest buyer of physical Gold. It is estimated that India will import “only” 35 tons of Gold in October, which if true, will be nearly 20 tons less than a year ago.

If the old adage that “history repeats itself” is true, then Gold prices have the potential to become much more volatile in the coming weeks. Looking back at the last big move in Gold and Silver prices in late 1979 and the first quarter of 1980, as well as the big bull market in Platinum in 2008, we notice that prices had moved “parabolic” in the waning days of these historic bull markets before the highs were in place. Though Gold prices have moved sharply higher the past several sessions, the recent moves have been nothing like those of the past bull markets in the precious metals sector. Although “this time may be different”, traders should be on alert for a possible capitulation by “Gold bears” before we see the highs in place for the current bull market in Gold, as well as increased price volatility as we trade in unchartered price territory.

Trading Ideas

With Gold prices holding near all-time highs, it should come as no surprise that Gold option volatility has risen, which makes purchasing individual options more expensive. One way to help mitigate the increased cost is by utilizing option spreads. Some traders who believe that Gold prices are headed even higher but who want to define their risk on a trade may wish to investigate bull call spreads in Gold futures. An example of this type of trade would be buying a February 2010 Gold 1075 call and selling a February 2010 Gold 1175 call. With February Gold trading at 1063.60 as of this writing, the spread could be purchased for 27.00 points, or $2700 per spread before commissions. The premium paid is the maximum loss on the trade, with a potential profit of $10,000 per spread minus the premium paid if February Gold is trading above 1175.00 at the option expiration in January.

Technicals

Looking at the daily chart for the most active December Gold futures, we notice prices accelerated to the upside once the recent highs of 1025.80 made on September 17th, were taken out on October 6th. Since that time, Gold prices have spiked nearly $50 per ounce, helped in part by the continued slide in the U.S. Dollar and the Dollar Index futures contract hovering near its lows for the year. Needless to say, Gold prices are well above both the 20 and 100-day moving averages, and momentum remains strong. The 14-day RSI is just reaching overbought levels with a current reading of 70.90, but is still below the extreme reading in the mid-to upper 80’s that signals a market in the midst of capitulating buying by those caught short the market. Since we are in unchartered price territory for Gold, resistance areas are tougher to gauge. As a rule of thumb, round numbers are viewed as potential technical points, so many traders are looking towards the $1100.00 area as a potential resistance target. Support for December Gold is seen at the previous near-term high of 1025.80 which is also near the current level of the 20-day moving average.

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