Are Gold Bulls Losing Their “Golden” Touch?

The bullish stampede into Gold has run into a bit of resistance lately, as the U.S. Dollar has staged a recovery from its lows, and a much better than expected U.S. non-farm payrolls figure on Friday has taken a bit of the luster out of the yellow metal.

Just a few days ago, many analysts and traders were looking for Gold to reach the psychologically important $1,000 per ounce level, as inflationary fears were running rampant with investors were fleeing the U.S. Dollar and moving into commodities (especially Gold). The extent of the speculative interest in Gold futures of late can be seen in the most recent Commitment of Traders report released this past Friday.

As of June 2nd, large non-commercial traders were holding net-long postions of 204,883 contracts, up 14,959 contracts for the week. Small speculative accounts are also net long Gold holding 40,556 contracts according to the COT report. This large and growing long position set the stage for a potential price correction, to shake out weak longs and those who entered the bull trend late in the game. This time the catalyst was the resurgent Dollar - especially last week, with the surprising drop of “only” 345,000 jobs in May, which sparked a major sell-off in the short-term interest rate markets, as talk of possible interest rate hikes entered traders conversations for the first time in many months. This helped to dampen some of the rampant inflation concerns that helped to drive Gold prices sharply higher this year.

Though “Gold Bugs” will argue that the current correction is actually healthy for the bull market because weak longs are weeded out, there are some concerns that Gold’s current failure as prices approach $1,000 may signal strong reluctance by traders and investors from paying four-digit prices for Gold. This can be seen in the Gold jewelry demand from India, one of the largest consumers of Gold, as consumers there are awaiting lower prices to ramp-up their purchases.

Although it is still too early to call a top in the Gold market, the large long speculative interest will need fresh bullish news to attract new buyers into Gold, or else much lower prices will be needed to drive “bargain hunters” back into the precious metals sector.

Trading Ideas

Traders who expect a potential rally in Gold prices this summer but believe a correction is overdue could potentially use both futures and futures options to position themselves in the market. An example of a potential trade is selling 1 August Gold futures and buying 3 August Gold 1000 calls. With August Gold trading at $950.80 as of this writing, the August 1000 calls could be purchased for about $1900 each, plus commissions. This trade hopes to take advantage of any temporary correction in Gold prices by having a short futures position, but it also has upside potential should prices become more volatile or move sharply higher by virtue of owning multiple long call options. The risk in this trade occurs if prices become less volatile (option time decay works against this position) or if Gold prices move only moderately higher by the option expiration in late July.

Technicals

Looking at the daily chart for August Gold, we notice a potential double-top formation, as the recent rally that took August Gold as high as 992.10 failed to match the February highs of 1008.90. Notice that prices are now hovering near the widely watched 20-day moving average. A close below this moving average could signal fresh selling by short-term momentum traders. The 1-day RSI has swiftly moved from overbought conditions to a more neutral reading of 52.10. The recent highs of 992.10 are now the next resistance point for August Gold, with support found at the uptrend line currently at 923.60.