Gold Falls $85: What to Do?
The gold market has been besieged by big sellers this week, culminating in a massive sell-off on Wednesday. At last check, COMEX gold futures had plunged $85, or 5.09%, to $1,585, which is $20 off of its lows for the session. The low of the day in gold on Wednesday, thus far, is at $1,565.70, which represents a multi-month low for the precious metal.
Yesterday, gold broke through a trendline which can be drawn from the low of 2011 at $1,309 which was put in last January. It appears that technical traders threw in the towel in the gold market once this trendline, which was offering support at roughly $1,675, was violated to the downside. Today's price action, along with the fact that the trend has been convincingly broken, does not bode well for gold in the near-term.
Similar to what happened in the S&P 500 when 1,250 was broken to the downside, the break of 1,675 in gold may be signaling that the metal will consolidate at lower prices for awhile. The catalyst for yesterday's move below this important trendline was the FOMC statement, where no new stimulus was announced and the Federal Reserve said that inflation appears to be moderating.
After the statement was released, gold immediately started falling. With the Fed on hold as far as more quantitative easing is concerned, a depressed housing market, and extremely sluggish labor market, fears about deflation are beginning to creep back into the market. This manifests itself most dramatically in the gold market.
Despite the near-term gloomy outlook for the shiny metal, there are a lot of reasons that traders may want to consider buying this dip aggressively. First, there is a 5-year trendline in gold that is still very much intact. This trendline comes into play around $1,532 and should offer support. Second, we have seen this type of price action repeatedly in a wide variety of commodity futures markets from silver, to gold, to sugar and oil.
The atmosphere is extremely volatile right now as traders are reacting primarily to monetary and fiscal policy developments in both the United States and Europe. From a long-term perspective, gold still has the best looking chart of any commodity and the stock market for that matter. In particular, there have been a number of very violent shakeouts in gold this year, but so far dip buyers have been rewarded for their courage. While the near-term technical picture has been damaged significantly, the long-term outlook still appears very bullish.
The fundamentals are also becoming even more compelling as the price drops. The world is experiencing a sovereign debt crisis which could be epic in its magnitude. Gold is priced in fiat currency, which is simply debt. As this debt crisis intensifies, investors distrust of fiat, debt-based currency will only continue to grow. Therefore, even in a deflationary, recessionary environment, gold should remain a relatively secure store of value.
Furthermore, recession fears and the overwhelming debt burdens in the developed world which catalyze them, will undoubtedly be met by even more central bank printing in the United States, Europe and Japan. Eventually this will happen and when it does, gold could easily top the $2,000 level in short order. The other fundamental dynamic that is effecting the short-term outlook for gold prices is taking place in the currency markets. The euro is in absolute free fall as a result of the EU's nearly untenable debt situation.
On Wednesday, the EUR/USD has plunged another 1.55% to $1.2971. The U.S. Dollar is experiencing a sharp spike higher as panicked investors flee the euro currency. Gold is priced in Dollars. Therefore, all things being equal, a stronger greenback exerts downward pressure on the gold market as a more valuable Dollar should, theoretically, be able to purchase more gold.
While this dynamic is very valid in the shorter time frames, it does not change the fundamentals which back the U.S. Dollar. Even as the value of the greenback rises due to flows out of the euro, the fundamentals continue to deteriorate. The Federal Government has accumulated a $15 trillion national debt, budget deficits for as far as the eye can see, and the Federal Reserve has proven that it is more than willing to print massive amounts of money in order to finance an out of control Congress and Executive branch.
Meanwhile, economic growth is dismal with no signs of a turnaround on the horizon. These are terrible fundamentals, and Europe's problems today will likely be our problems tomorrow. As a store of value, gold is basically immune from these problems. Therefore, when the Dollar rises, and gold falls, it is an ideal time to add to physical gold holdings if you agree with the thesis presented here.
Investors who are frightened by the current volatility in the gold market, but see the decline in price as an opportunity, may be interested in some hedging strategies. The most obvious and straightforward method of hedging a gold portfolio right now is to short the euro. If the euro continues to decline, resulting in a corresponding rise in the U.S. Dollar, gold could also go lower.
Alternatively, if the euro rallies, it will likely result in a move higher in gold and other risk assets. If you are interested in jumping into gold this week, but are worried about the large price swings, consider shorting the euro along with your gold purchases. This could be done by shorting the CurrencyShares Euro Trust ETF (NYSE: FXE), shorting euro futures, or shorting the EUR/USD in a Forex account.
Furthermore, investors could buy put options on an ETF or futures contract which will increase in value if the euro continues to fall. Determine the size of the position based on how much of your gold purchases you would like to hedge.
ACTION ITEMS:
Bullish:
Traders who believe that the decline in gold is a buying opportunity might want to consider the following trades:
- Purchasing physical gold through a bullion dealer.
- Purchasing gold futures contracts in a futures trading account.
Bearish:
Traders who believe that the decline in gold is just getting started may consider alternate positions:
- Purchasing put options on the SPDR Gold Trust ETF (NYSE: GLD)
- Shorting gold futures or buying put options on gold futures.
- Purchasing securities that will benefit from a continued rise in the U.S. Dollar.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.
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