Overbought Gold Market Presents Opportunity To Short Sell

Gold prices have been climbing lately as investors seek shelter from the threat of inflation. Will gold continue to rise to record levels, or will there be a …

Gold prices have been climbing lately as investors seek shelter from the threat of inflation. Will gold continue to rise to record levels, or will there be a large sell-off when the dollar stabilizes? See the following article from The Street to learn why it might be a good time to short gold.

Gold has been trending higher over the last several weeks based on inflationary fears. Certainly one can make the argument that loose fiscal policy will drive inflation in the future.

The record U.S. deficits are alarming, and the printing presses have not yet come to a halt. How will the Fed enact its exit strategy? These are all questions feeding investors’ appetitie for gold.

In addition, risk appetite has come back into the markets in a major way. We are seeing commodities trading higher this week. Crude oil back in the $70s, copper at almost the $3 mark. And the lowly greenback trading at the lowest level in almost a year.

While many countries are currently looking at tightening credit, the U.S. has made clear that it is too early to tighten. And although the Fed has perhaps dodged the “deflationary bullet,” we are probably looking at a period of sluggish economic growth, and at this point tightening would be slamming on the brakes to what positive momentum has been achieved thus far. Economically, some improvement has been seen, but is it enough to continue to drive investors into riskier asset classes and currencies? I doubt it.

Gold is up approximately 13% this year, and assuming it ends the year higher will have gained each year for the past nine years. Holdings of bullion in the SPDR Gold Trust(GLD Quote), the biggest exchange-traded fund backed by the metal, are once again approaching their record. Gold producers are removing their hedges in anticipation of prices moving higher. And investors, retail and institutional, continue to be drawn to gold’s allure.

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I think there may be some interesting, tradeable opportunities in this market in the coming days or weeks.

The dollar will remain the main force behind gold prices in the near term, so we will be closely montiring the dollar index. We must also continue to examine the risk appetite vs. risk aversion. After the rally we have seen in equities and many commodities, will the notorious months of September and October prove to be more than the markets can bear?

Will we see the elusive pullback so many of us have been expecting? If we do see some sizable profit-taking or pullback, the dollar will most likely begin to stabilize, and perhaps gain little traction as investors return to perceived “safe haven” assets and currencies.

Looking at gold, it seems to me that dollar doom has already been priced into the market, and any indication that the greenback is bottoming could spell disaster for gold prices. Therefore, I think there may be some opportunities on the short side of the market.

One must be careful, however. It is quite possible, in fact likely, that the market is lined with buy stops above 1000 on the S&P, looking for the “clean breakaway” move. It is quite possible that gold could make a vicious move up to 1050 or even 100 on stop-running and panic-buying. This to me would present a good short opportunity. This could possibly constitute the beginnings of a “blow-off” top.

So what we are looking for is a dramatic, rapid move higher followed by immediate weakness. In other words, a steep rise followed by a steep fall. In my opinion, this would provide a good opportunity to get short this market by either selling futures contracts, selling call options, or both.

On the other hand, we may see gold meander around 1000 again and fail as it did in March 2008, eventually plunging to around 860 by the first week of April. Again, if one is going to choose this market as a dance partner, it is important to look for some confirmation first before initiating a position. I will be looking for any indication of weakness at these levels as many are taking profits around the 1000 mark. The market is very overbought looking at an RSI.

That does not mean it can’t keep going higher, it just tells us that we are probably getting closer to proft-taking and a pullback in prices, and this pullback may only be temporary. We want to see this indicator begin to fall from overbought readings. I will also be looking for confirmation by using a candlestick chart. I will be looking for specific bearish patterns such as the Harami Cross.

Finally, I think that if we break back below the highs of June around 991 on the October futures contract that the selling may intensify. Again, we will be looking to establish short positions in this market through the sale of futures contracts, call options or both. Patience is key. Let the market come to you. One of the quickest ways to go broke in trading is trying to call tops and bottoms. Wait for confirmation first. Remember, as premium collectors, we are only looking at the short term.

Although I think the long-term prospects for gold are quite good, this market in my opinion is currently overbought, and the more overbought, it gets the more likely it becomes that we will see prices coming back down to earth in a swift manner, especially if we see a technical failure at the psychologically important 1000 level.

Risk disclosure: Past performance is not indicative of future results. The risk of loss in trading futures and options is substantial and such investing is not suitable for all investors. An investor could lose more than the initial investment.

This article has been republished from The Street. You can also view this article at
The Street, an investment news and analysis site.


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