Chasing $1,000 Gold
Many market watchers have been watching and waiting for gold to hit $1,000 an ounce. I've had questions from clients about how to trade "psychological" levels like this, but avoid what's called "chasing the top."
It's true that within powerful trends, there are key technical levels, so-called "psychological levels" that can act as tough resistance. For gold, it's been $1,000. We saw $100 as a key psychological level in crude oil for a long period, and even though it was surpassed this year, the market has had a hard time breaking significantly above it to a new leg higher. Often when markets reach these key levels, we see big corrections as those waiting and anticipating these moves turn to taking profits.
But what we have to do is look at the big-picture fundamentals, and what will take the market past these key levels to a new range higher. We have seen incredible moves out of gold over the last few years and the eventual rise above $1,000 an ounce could be right around the corner. The U.S. dollar has been trading lower against a host of major currencies, and hit an all-time low against the euro this week.
We've seen a strong inverse relationship between movements in the dollar and gold. Continued dollar weakness should cause the bullish momentum to continue to take gold higher over the next year, even if we see some short-term corrections along the way. COMEX April gold futures have surged above $970 per ounce, so we are not that far off from this closely watched price level. If we have a continued devaluation of the dollar, gold will likely continue to take on its "reserve currency of the world" status. In testimony this week before Congress, Federal Reserve Chairman Ben Bernanke opened the door for further interest rates, expressing more concern about a week economy than inflation. Fourth-quarter gross domestic product grew a paltry 0.6 annualized rate in the fourth quarter.
So, one way to determine whether a strong trend will continue in one market is to watch action in other related markets for clues. Some markets affect each other not just conversely, but in tandem too, such as grains and livestock.
There are two ways to play this type of situation where you want to get involved in the trend. In the case of gold, you can buy futures (which have unlimited risk and unlimited profit potential) and pick a level to minimize your risk if the market falls, by using a stop. However, if the market corrects and your stop is hit, you are out of the trade, even if the market moves back up even higher soon after.
If you want to get the most possible return on your idea and avoid getting stopped out, I would consider buying gold call options. This can help alleviate some of the risk of "chasing the top" if the market does face a short-term correction. The benefit to taking the options approach is that there is a defined risk, so you know what your maximum loss will be if you are wrong. Options are a time-sensitive instrument that require the market to move to a particular point by a stated time, so the negative aspect of this approach is the fact that the move needs to be made above the option strike price before the expiration date of the option.
On the plus side, you have time for the market to work its way back to where you think it should be by expiration without blowing out of your position or seeing your losses magnify. For example, if you bought an 1100 June gold call, you have until May 27, 2008, when the option expires, for the market to move above your strike price. If the market hits $1,000 and pulls back to $900 in March, you still have two months for the market to work its way back up above $1,100.
Adam Klopfenstein is a Senior Market Strategist with Lind Plus. For more information on this topic or to tailor a customized trading strategy in any market you are interested in trading, you can reach him at 800-266-0551 or via email at aklopfenstein@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
