Friday, December 18, 2009

Gold Rally Still Holding Up

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Gold had a horrendous day on Thursday, December 17th. The price dropped below $1100 for the first time in many weeks. In mid-day trading in New York, there was a sudden vertical drop that was bound to give most investors pause. While gold went up almost every day in November, it has been mostly on a downward path since the beginning of December. Does this mean the gold rally is over? No, not at all. It just means that gold doesn't go up every day.

The cause of the recent volatility is Friday, December 18th's quadruple witching. Stock index futures, stock index options, stock options and single stock futures all expire on the same day in a quadruple witch and this only happens once every three months. The impact of the expiration can frequently be seen a day or two before and that is what investors were witnessing on Thursday. Prices will tend to move to minimize the value of the outstanding options. The big trading houses are major options sellers and they lose a lot of money otherwise if this doesn't happen. This has been an important factor lately in driving gold down and the U.S. dollar up.

The bears of course have been claiming the gold rally is over. They started doing so the first day gold dropped. The price action we are seeing now is reminiscent of the pull-back in December 2007. GLD, the major gold ETF, broke the 50-day moving average line then, just as it did now on December 17th. Gold had trouble rallying for four weeks during the month, but then the second phase of the rally followed. This took GLD up to much higher highs before it peaked in March. January and February are traditionally two of the strongest months for gold.

Spot gold hit key support which is around $1100 on the 17th. The 61.8% Fibonacci retracement for the rally that started in early October is in that area. That rally is still in effect until there is a significant break of that level. Just as gold was overbought on the daily charts before the recent sell off began, it is now oversold. The U.S. trade-weighted dollar was oversold and it is now overbought. Gold and the dollar usually move in opposite directions. Oversold conditions in bull markets are more important than overbought conditions and the opposite is true for bear markets. Therefore a good possibility exists that there will be some price reversal in both bullish gold and the bearish U.S. dollar soon.

Spot gold was around $1110 at the end of floor trading in New York on Friday. As long as it closes at or above $1100, especially at the end of the week, claims that the current rally is over are premature. Even if there is some pause to the rally, nothing has changed in the longer term picture. As long as there is easy money from the Fed - and raising interest rates from zero to a half a point or even a point or more - is still easy money and the federal government continues its spending spree, the backdrop for a gold rally is still in place. Don't expect this to change any time soon.

Disclosure: Long gold.

NEXT: The Three Big Economic Lies of 2009

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


Steven said...

The US government has thrown such a large amount of money at the problems that it has temporarily stabilized the economy. But this comes with a lot of consequences, and the current expansion of the money supply is not sustainable because it will severely damage the value of the dollar and create a significant inflation problem in a few years. That is why I feel gold is one of the best asset classes to invest in currently given its safe haven status and that it is denominated in dollars. This article is a further discussion on these issues Canada Gold Investing 101, which analyzes the relationship between the dollar, the gold price, and gold mining companies as a result of the Federal Reserve's easy monetary policies. I thought it was especially helpful for investors to read to get a better sense of the dynamics between the various sectors of the financial markets to improve their investment knowledge.


Great rally