Gold: Are we starting the “Pause that Refreshes?”

by JDH on October 16, 2010

So today we return to the same question we have pondered for many weeks: when will gold take the “pause that refreshes?” These are strange times, as we witness a strong stock market, a record high gold market, and a weak U.S. dollar. Let’s review the charts (I have left the charts small; click on any chart to enlarge); first, gold:

Since the last week of August gold has had a virtually un-interrupted rise. I don’t see more than four days in a row of price weakness. That’s amazing. On Friday gold was down just under 1%, so if you are counting, that is now exactly 1 day in a row of weakness. Will it lead to more next week? Who knows.

The RSI is back down to 73, which is still a very high, overbought level, but obviously less than the almost 90 level we were at earlier in the month.

As I have continued to stress over the last few weeks ( Don’t Worry, Be Happy, Gold and the Markets to Pause, or Patience – Gold will shine, but a small pullback is probable), I am still of the view that a pause is both inevitable and necessary, and I expect it to occur at any time. My working theory is that the markets will remain strong leading up to the U.S. midterm elections on November 2, and thereafter it won’t be pretty. Speaking of the markets:

Interestingly, the chart of the S&P 500 looks similar to the chart of gold. Gold has risen since the beginning of August; the markets have risen since the start of September. Gold is at a new high, and the markets are now around the high point for the last four months. For the last month they have moved together. Why?

Good question. “Normally” gold is a “flight to safety” investment; we buy gold when we think the world is going to end. Obviously with the stock markets going up, “we” don’t think the world will end. Presented another way, here’s a chart of gold, denominated in SPX terms:

As this chart shows, over the last month gold, priced in terms of the S&P 500, has not moved. In other words, they have both advanced at approximately the same rate. That leads to this obvious conclusion:

The markets are NOT going up. They are flat. They only look like they are going up if you measure them in terms of U.S. dollars, which are dropping.

Sure enough, the USD dollar is dropping. If you chart the S&P 500, or gold, in terms of dollars (which is how we measure things), they appear to be going up. In fact, it is the dollar going down that makes it appear that they are going up.

Clearly the USD is not holding it’s value. Clearly gold has become money. Investors are disposing of USD and replacing it with gold as a store of value. So what’s next?

First, the U.S. dollar looks very over-sold at the moment. With an RSI of 27, a short term bounce is almost inevitable. Gold is looking over-bought, so again a minor correction appears almost inevitable as well. So, I would assume that over the next few weeks gold will ease down, and the U.S. dollar will increase.

Of course that will only be a temporary event, and by the end of the year, probably sooner, gold will be back on a run. So, I will use these brief pauses as an excuse to deploy my cash.

I will also continue my strategy of selling short term call options against the blue chip gold and silver stocks I own. On September 24 I covered my stocks by selling October calls; on October 15, options expiration day I bought them back Here’s how it worked out this month:

In summary, on my four trades I made money on three of them, and broke even on the fourth, ignoring commissions. However, the underlying stocks also increased in value. For example, AEM.TO – Agnico-Eagle Mines Ltd. was trading around $72 on September 24, and closed on Friday at $73.49, so even though I didn’t make any money on the options, I still own the underlying stock, at a profit.

In effect I “rented” out my stock for three weeks, and pocketed the rental fee. Had the stocks shot up in value I would have lost the upside, but they didn’t. This strategy makes sense because I want to own the underlying stocks. I don’t want to sell them because long term I believe they will go up in value. Short term I’m not so sure, so a short term rental strategy makes sense.

For this week I will continue to watch. If we have weakness on Monday I may buy a few more blue chip shares and immediately cover them, but I assume that I will not be doing any significant buying until November.

That’s the game plan for now. Thanks for reading. See you next week.

{ 1 comment… read it below or add one }

designer October 23, 2010 at 1:09 pm

Here is a site that is worth checking out as far as the direction of the Canadian markets are concerned.

“CDNX is in the midst of a massive move of historic proportions that could ultimately (sometime over the next 12 to 18 months) take this Index over 3,400 to a new all-time high.”