Gold Oversold or Just Over?

Posted On October 14, 2016 1:43 pm

There is no asset in the world that generates as much love and hate as gold. There is not a day goes by without a multitude of extreme predictions on where the yellow metal is going. Lately it seems more hated, as it sunk some 7% since the summer highs.

More revealing of the yellow metal having lost its luster as a safe haven or alternate currency has been its failure to rally, even during the “risk off” days. Even during the recent acts of terror, or on September 9th when stocks and bonds tumbled sharply, usually sending investors fleeing into the precious metal, gold barely caught a bid. In fact, it seems gold is only responding to negative developments, such as the stronger dollar, hence we see it sitting near 6 month lows and in an oversold condition.

After gold has had a sharp rally or sell-off, the calls for it booming or busting intensify as emotions run wild. We are in one of those periods now, in which gold looks technically oversold and near support but the fundamental picture looks mixed. Let’s take a look at what gold has done after previous oversold conditions.

Its 14-period RSI (a technical indicator that can range from 0 to 100, where 0 is maximum oversold and 100 is maximum overbought) is at 27.83. Going back to 1972 (first year off the gold Standard), this reading is lower than 97% of daily readings. So it’s pretty extreme in a historical context.


Removing emotion from the equation, what does this tell us about forward returns?

Going back to 1972, forward returns for gold are above average in the following 1 week through 3 months, but below average in the following 6 months through 12 months. In all periods though, the average forward returns are positive.


Is there anything different about the oversold conditions today as compared to other oversold periods? Yes. It is occurring with Gold in a long-term uptrend (above its 200-day moving average). How have returns fared historically following an extreme oversold condition in an uptrend?

Significantly better, with outperformance in all time periods. However, you’ll notice the sample size is much smaller. This is only the 55th time gold has been extremely oversold in an uptrend going back to 1972.


All of this may be interesting but you still want to know: where is gold going from here? What’s the call? What’s the target?

I don’t know and neither does anyone else. All we have is historical data, probabilities, and a range of possible outcomes. The above tables are merely average returns and do not provide any certainty as to what will actually happen. There are many, many instances where gold was oversold and continued to fall.

The best we can say in observing gold in an extremely oversold state is it tends to rise on average over the next year and if it’s in an uptrend (as it is today) it tends to rise more than other periods. Not an answer suitable for TV punditry, but if you’ve read this far you likely value evidence over subjective opinion.

Given the above data and the current support near $119 level this seems a reasonable place to try a lost cost bullish option play.

I’m using a diagonal calendar spread, specifically;

  • Buy the December 119 calls and sell the November 123 calls for a $2.35 Net debit.


About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.