Gold’s Make or Break Moment

Posted On December 16, 2016 11:48 am

Gold prices have been sliding for the past few months but the selling pressure accelerated this week following Wednesday’s FOMC meeting when Yellen & Co. indicated they plan on hiking rates three times during 2017.

Higher rates take investment dollars away from the inert metal, which has no cash flow and offers no yield. And the need for gold’s role as a hedge remains muted along with inflation expectations.

Looking at the SPDR Gold ETF (GLD) we can see shares broke important support at the $115 level following the election and this week’s gap down places it right at longer term support at the $107-$108. It would appear gold is now at its make or break moment.

The sell-off in gold has also not surprisingly been accompanied by an increase in bearish sentiment and short positioning. As you can see from this chart, Commitment Of Traders is now its most bearish in over three years. This type of extreme can lead to a short covering rally if gold holds the current levels.

Another factor weighing on gold has been the rise in the U.S. dollar. Since gold is based in dollars the strong dollar makes it more expensive for foreign buyers such as China and India which use gold as an alternative currency.

As you can see the dollar/gold ratio is now at an important inflection point. I think the risk/reward favors a near-term pull back in the dollar which would be bullish for gold.

Lastly, we see the velocity of the recent selling has pushed gold to an extreme oversold condition. In the past such levels have provided reliable buy signals.

This all adds up to what I think presents a decent risk/reward for a short-term bullish trade in gold. I would use a basic vertical call spread in the January expiration. I’d look to buy the 107 calls and sell the 110 calls for a $1.30 net debit. This provides a nice low cost, limit risk, and the possibility of over a 100% gain.

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.