Wednesday, February 9, 2011

Time To Go Long Gold Again?

While gold has been selling off since the beginning of the year, it is still in the midst of a long-term uptrend (as evidenced by the 2-year weekly up channel in the GLD chart below).

The fundamental case for buying gold is already well known (increasing debt, weakening currencies, inflation concerns, etc) so I won't rehash the bull-case here. I don't consider myself a "gold bug", but I do believe the bull-case has sufficient merit to propel gold prices to new highs at some point this year.

So the fundamentals point to higher prices, but what about the chart? No matter what the fundamentals say, there's no point putting good money into a trade like this until the fundamentals and the chart are in agreement. My analysis suggests that time may be now.

Most importantly, GLD has regained its 100 day moving average (100dma) and has closed above this level for two consecutive days now. The last time GLD dipped under its 100dma was last summer. Once it rose back above its 100dma it went on to rally 16% in less than 3-months. In addition the MACD indicator has recently crossed over and is now headed back up again from oversold levels.

Why is the move back above the 100dma important? The 100dma, along with other indicators like the 200dma, represent longer term trends in the underlying stock or commodity. When the price of the underlying dips under one of these averages it serves as a warning that the long-term trend may be starting to turn down.

However, sometimes this move under the moving average is nothing more than a shake-out of weak longs. Those traders that got long near the highs are pressured to sell once the price falls below its moving average. Other traders may look at this apparent weakness as an opportunity to go short.

In cases like this I will often watch the price action in anticipation of a move back above the moving average. A move back above the moving average can be a great signal to go long. I like to think of it as a "slingshot-wrap-around-reversal". The price has a tendency to snap higher, like a stretched elastic band, as previous longs and existing shorts scramble to buy. The probability of this being a winning trade is increased if the moving average itself is in an uptrend (as it is with GLD).

GLD looks like a great risk/reward trade here at 133 with a stop under the 20dma (currently at 131.71). The initial upside target would be a test of last year's highs between 138-140.

Other ways to play a bounce in gold would be to go long gold miners like Barrick (ABX) or the gold miners ETF (GDX).

I am long HBU.TO (2x gold ETF) and ABX.

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