Sunday, December 6, 2009

Gold Market Thoughts

Gold spot prices fell more than $50 on Friday, its largest decline in 20 months. This translated to a loss of $4.95 (-4.17%) to $113.75 on GLD, the SPDR Gold ETF. We have been trading GLD rather successfully since 2005 so we wanted to post an update on the five year price history of gold, how we are currently positioned and how we are looking to position ourselves going forward.

Let's start by taking a look at a current six month candlestick chart of GLD with Bollinger Bands.  Notice that GLD rode the top of the band for the entire month of November.  The big drop on Friday did not even bring the current price down to the middle of the band, a reasonable short term entry point (click on images for larger views):

Next let's look at the same chart with the 100 and 200 day moving averages.  Notice how far GLD moved above its trend lines and how far the current price still is from these lines:

The steepeness of this ascent is more apparent by examining a five year chart with the 200 day moving average.  Shaded in grey are two other periods where GLD extended far beyond its moving average:

From March 23 to May 11, 2006, GLD rose from $54.70 to $71.03, a rise of 29.85% in less than two months.  We remember this period fondly because we went long GLD for the first time in November of 2005 and promptly exited our position in the first week of May, an admitted stroke of luck since we knew very little about gold at the time.  From May 11 to June 14, GLD fell back to $56.62, a fall of 21.70%.  GLD fell below its 100 day moving average but stayed above its 200 day moving average.  It took four more months of choppy trading action for GLD to fall below its 200 day moving average and make its final bottom:

We rebuilt our position in GLD slowly throughout the rest of 2006.  GLD had a rather smooth if unspectacular rise though most of 2007 until it broke out in September.  After a brief correction in November and December, GLD rose from $78.67 on December 20, 2007 to $96.50 on March 17, 2008, a rise of 22.66% in less than 3 months.  Like the previous time GLD got so extended, we again exited or position and spent the rest of the year concentrating on the banking crisis and very little time watching gold.  This was fortunate because GLD fell back to $83.99 by May 1, a fall of 12.96% and below GLD's 100 day moving average but above its 200 day moving average.  Further collapses occurred in Autumn, where GLD finally made a bottom on October 24 at $70.65, a fall of 26.79% from its peak in March.  This time GLD fell below both its 100 and 200 day moving averages:

As the banking crisis began to wind down and GLD moved back above its moving averages, we rebuilt our position in GLD from March to June of 2009.

Over the last two weeks and before Friday's decline, we have closed out 80% of our position. Our reasoning was that this run up had quickly begun to resemble the peaks in 2006 and 2008, so a sell off was imminent. Friday turned out to be the day of reckoning and we think this is just the beginning of a much larger correction.

If previous peaks are any indication, this correction will last at least one to two months for the initial fall, where GLD will fall 15-20% and below its 100 day moving average but stay above its 200 day.  This should place GLD somewhere around $100, with a gold spot price of $1000.  GLD will then trade sideways to down for the next four to seven months, where it will reach its bottom below its 200 day moving average sometime in the spring or early summer.

We feel fairly confident about the first scenario playing out but only mildly confident about the second scenario.  We don't give investment advice but we will personally be buying back in full under $100 on GLD and $1000 on spot gold.  If gold falls even further, we will likely be buying even more, and could end up with an outsized portion of our net worth in the yellow metal.

We have shown how under $1000 is a good technical entry point but it is also an excellent area from a psychological perspective as well. Back in November, Marc Faber proclaimed that gold will never fall below $1000 again. Faber has been very astute since we have been following him so we don't dismiss his ideas lightly.  With that being said. we see no reason why $1000 should hold and in fact we feel that when gold does break this level, there will be final capitulation selling where gold will fall to $950-980 where we will have an excellent entry point.
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