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Gold Forecast: Q4 2011

Slovakiuh-oh: How to Trade Gold Now

By

Suddenly, everyone is an expert on all things gold and silver.

They’re all seasoned economic pundits, dissecting the end of the risk aversion trade to the dollar and all the reasons that gold and silver are the place to be.

At least 12 people have told me they absolutely “knew” gold would run higher from here...

Silver? A no-brainer. The dollar? It’s coming down for sure.

My son’s kindergarten teacher, the cro-magnon security guard at the school, the Arab guy who makes my turkey sandwiches — they followed billionaire John Paulson’s gold trade and told me to buy when it popped to $1,850 an ounce. They lost thousands.

Paulson's the guy that made billions on the housing collapse. But as the saying goes, past performance does not equal future gain.

“Stop crowding the trade thinking you know what you’re talking about,” is what I angrily thought about saying to these people. (I decided to hold my tongue. Some of these folks were officers with 45s on their belts.)

On my way to pick up last-minute Tony Bennett tickets last night, the taxi driver, Amir, asked me where gold is heading.

He then told me, “I lost a bundle on gold this year. I jumped in at $1,900.”

I didn’t have the heart to tell him I’ve been in gold since $600 — or that calling the top at $1,900 was child’s play.

“You might have better luck playing a possible bottoming out here around $1,600, depending on the euro situation,” I said as I darted from the cab before having to explain further. All I wanted was 10 minutes alone with no one talking about gold and silver, and I couldn't even get that.

But it got me thinking: How could a smart, respected billionaire like Paulson screw up the gold trade and lose so much money?

Talking the Talk

Calling that top was child’s play on an overextended move. Then again, maybe Paulson's not reading Wealth Daily.

It should have been as obvious to Paulson as it was to me that gold was topping out after an overextended run.

Back in August, I reminded investors we have to be realistic with gold when I wrote an article about hedging gold prices:

Gold has simply run up too far, too fast. It's up close to 35%, or $500, since January 2011. And it's up close to 18% in just the last few weeks. Heck, it broke $1,900 the other night, less than two weeks after hitting $1,800.

The herd is far too bullish. Gold margins could get hiked again. It's technically overdue for a significant pullback on overextended conditions. Just look at the Bollinger Bands, RSI, and MACD reads. Gold has rallied too far, too fast.

Gold would fall from $1,900 to around $1,600, sending our recommended November 2011 170 put (GLD111119P00170000) side of the straddled option skyrocketing.

gold chart 101211

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Time to Go Long Again

The Slovakia vote is not the end-all-be-all vote.

Yes, it throws Europe out of whack for a bit. However, a second vote maybe this week — or even new information at the October 23rd eurozone summit — could still be obtained.

Sixteen countries have already approved a bill to strengthen the European rescue fund, but Slovakia has been holding out. And in order for the measure to go through, a unanimous vote of euro-using countries must approve it.

If Slovakia were to vote "no" a second time, we could see the debt issue complicated further.

So as we wait for Slovakia to make up its mind, here are some bullish cases for gold upside...

The dollar has overextended its run at the latest peak. Anyone that wanted to buy the dollar has already done so.

dollar chart 101211 

The “risk on” trade is back on the table, depending on Slovakia.

  • Capital is re-entering gold as investor risk appetite returns. Risk aversion sent them to the dollar.

  • Countries around the globe are prepping bailout packages and stimulus programs; debt-ridden banks and countries will continue to give investors a solid reason to buy back into gold.

  • German Chancellor Merkel and French President Sarkozy have announced they'll proposed important changes to just how the eurozone will operate by month end.

  • The Belgian government is nationalizing the Belgian half of the French and Belgian Dexia.

  • Greece is out rescuing Proton Bank.

And we're not the only ones calling for a run on gold: Credit Suisse just upped its 2012 gold forecast to $1,850. Morgan Stanley expects the metal to run to $2,200 sometime in 2012. And one of this year's most successful hedge funds, Duet Commodities, is looking for $2,000 gold in the next three months.

How to Trade It

Buy gold on the dips — and short it every time it overextends itself.

If gold can break out of its consolidation pattern to the upside, we could see a return to $1,700 in no time — maybe even $1,900 before the year lets out.

One way is to play it with option straddles. For example, you'd buy a straddle in the case of Slovakian-led downside in gold.

You can do that by buying an equal number of SPDR Gold Shares (GLD) November 2011 163 calls (GLD111119C00163000) and GLD November 2011 163 puts (GLD111119P00163000).

Or as Andrew Mickey has pointed out, take a look at oversold junior resource stocks, which haven't run as they should. We expect that to change, though. Fundamentals have never looked so good.

You're being handed a gift with gold this low...

Don't miss the opportunities as they knock.

Stay Ahead of the Herd,

Ian Cooper Signature

Ian L. Cooper
Analyst,
Wealth Daily


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