Goldilocks without the Bears

08/18/2011 10:18 am EST

Focus: COMMODITIES

Thomas Aspray

, Professional Trader & Analyst

Extreme bullish sentiment and technical indicators signal that a pullback in gold and popular ETF GLD could lie ahead, and a covered-call option strategy may be the best way to profit.

The more-than-20% gain in the SPDR Gold Trust (GLD) since the July 1 close has been relentless, and domestic and global news has provided daily reinforcement that gold is the only “safe” investment.

As gold has powered to several new highs over the past two weeks, the only thing missing has been analysts who are voicing even a short-term bearish outlook for the yellow metal. In fact, it has almost become un-American to question whether gold will ever stop going higher.

It is important to separate the short-term from the long-term trend analysis. The monthly on-balance volume (OBV) analysis of both GLD and the Comex gold futures is still pointing higher, as it has been for the past seven years. The same is also true for the weekly analysis, so one might ask, “What’s the problem?”

The Starc band analysis can be used to identify high- and low-risk areas to buy or sell based on daily, weekly, or even monthly time frames. When a market reaches a historically high-risk buying area using both the weekly and the monthly analysis, the odds of some consolidation or a more significant pullback are very high. From a money-management point of view, this can allow even long-term investors to protect profits by hedging their positions.

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Chart Analysis: The monthly chart of the SPDR Gold Trust (GLD) shows that we are currently trading above the monthly Starc+ band at $173.30. The monthly Starc- band is at $133.56.

  • Since 2006, this condition has only occurred twice. In April and May 2006, GLD traded above the monthly Starc+ band (point 1). By June 2006, GLD had dropped 23.8% from the May highs
  • GLD also traded above the monthly Starc+ band for three months from January through March 2008 (point 2), as it rose 20% from high to low
  • This was followed by an eight-month correction that took GLD from $100.44 to $66, which was a 34.3% decline
  • The monthly OBV is now above the April 2011 highs and shows a pattern of higher highs since 2006

On the weekly chart of GLD, I have highlighted those times when the weekly Starc+ band analysis has identified a high-risk level for buying.

  • For the week ending May 13, 2006, GLD closed above the Starc+ band for the fourth consecutive week (point 3). The following week, GLD closed below the prior week’s low, signaling the start of a correction
  • In 2008, GLD tested the Starc+ band many times but only traded above it for one week
  • In late-November 2009 and into early December (point 4), GLD traded above the weekly Starc+ band for two weeks before starting a multi-month correction. GLD declined from a high of $119.54 to a low of $102.28
  • In April and May 2011 (point 5), GLD traded but did not close above the weekly Starc+ band and then consolidated for the next eight weeks
  • The April high was confirmed by an upside breakout in the OBV, as it overcame resistance at line d. The OBV has made significant new highs over the past few weeks, which is bullish for the intermediate term
  • The insert shows that GLD traded above the weekly Starc+ band both last week and this week
  • The long-term uptrend on the weekly chart, line c, is currently at $142

NEXT: Latest Daily Chart for GLD; How to Profit

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The daily chart of GLD shows the close on Wednesday, August 10 was well above the daily Starc+ band. It is now at $178.23.

  • The key swing support on the daily chart is now at $167.77 and a violation of this level would suggest a drop to the 38.2 % retracement support at $163.27
  • The 50% support is at $159.70, which would be just an 8.8% drop from last week’s highs
  • The daily OBV did confirm last week’s highs with support at line a and its weighted moving average (WMA)
  • Volume has been light this week (circle b), which may be telling us something

The October Comex futures hit a high last week at $1815.80 and closed Wednesday at $1792.20. The daily Starc+ bands were exceeded three days last week and the Starc+ band is now at $1836.90.

  • There is key support for the October Comex gold contract at $1716-$1724. The daily uptrend, line c, and the 38.2% support are at $1691-$1686
  • The 50% retracement support is at $1646 with the 61.8% support at $1609
  • The Herrick Payoff Index (HPI) is one of the few indicators that use volume, open interest, and price. When it is above the zero line, it indicates that money is flowing into a commodity
  • The HPI has been above the zero line since January 11 (not shown) and has surged over the past month
  • It is clearly still positive, but the HPI shows a potential short-term top formation. A drop below support at line d would be a sign that money was starting to flow out of gold

What It Means: The last month’s action in gold and the SPDR Gold Trust (GLD) has been impressive, and both can still move higher from here. However, the Starc band analysis indicates that in the next month or so, a significant pullback is likely.

The recent hike in margin rates by the CME may be the first warning shot, and gold is sharply higher in early trading today with stocks once again under selling pressure after the CPI numbers jumped.

Further new highs in the gold futures are likely to be met with further margin increases. In the past, two to three margin hikes have been enough to reverse the short-term trend in a commodity market, and we saw a great example of this in silver last May.

How to Profit: A correction in GLD could easily take the fund back to the $155-$165 area. For those who are long GLD and want hedge their positions against a decline, then a covered-call option strategy may seem attractive for those who are familiar with options.

Depending on your cost basis for GLD, you may want to establish this strategy at current or even higher levels. For example, the October 180 calls closed Wednesday at $4.85. If you sold this call against your existing long GLD position and had the stock called away at $180, your actual sale price would be $184.85, which is almost 6% above Wednesday’s close. 

If this strategy is established and GLD drops into the $156-$161 area, look to buy the option back.

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