Gold Rocking, But I’m Covering

by JDH on September 8, 2012

It would appear that, if you are an investor in gold or gold stocks, September is off to a roaring good start.  All is good.  On Friday gold closed up over 2%, closing at $1,737.60, a multi-month high.  Will it be a straight shot to the moon from here?

Perhaps, but probably not.

As the gold chart indicates, this week we exceeded the peak back at the end of March of $1,700, closing above it on Thursday, and blasting through it on Friday.  A round number like 1700 is psychologically important, so blasting through it is a good sign.  It means that the Big Boyz were not able to keep a lid on it on Friday.

However, I don’t believe we are in for a straight, uninterrupted ride to $50,000, because that’s not how it works.

For starters, the RSI is now over 80, and any time the Relative Strength Index gets over 70, the possibility of a near term correction increases.

Also, if one observes a longer term chart, a blast off appears less likely:

This three year chart of gold illustrates a few points:

First, the correction that started with the peak back in the summer of 2011 is now over.  The red down-trend line is quite obviously broken, and that’s very good news.

Second, obviously, the blue uptrend line remains in place.

Third, the wedge formation, bounded by the blue uptrend line and the red downtrend line is also violated, and that’s good.  A wedge means that gold is trying to both go up and down at the same time (albeit on different time scales), and clearly that’s not possible forever.  The wedge was broken to the upside, so we now know which way gold is going: up.

Fourth, the RSI at the top of the chart remains in a strong upchannel (as indicated by the green lines).  It is therefore possible that gold could continue to increase for another week, or two, or more.

Finally, the MACD, at the bottom of the graph, is not yet as toppy looking as it was last summer, so again there may still be room to run.

So with all of this positive evidence, why don’t I think we continue going forever?

Because when you look at a longer term chart, you can see this pattern before.  I’ve identified, with boxes, three other periods where the RSI has bounced over 80.

At the end of 2009 it was there for about a month, before gold corrected from around $1,225 to $1,075 in about two weeks, for an over 12% drop.

In May of 2011 the RSI was only over 80 for just over two weeks, and gold went from a peak of around $1,580 to $1,480, a drop of 6% in two weeks.  It’s possible that we are at a similar inflection point.

Perhaps the most analogous time to where we are now started in mid-September, 2010.  Gold had bottomed in the summer at around $1,175, and the recovered throughout August (just like this year).  The RSI crossed over 80 in early September (just like this year), and continued running up to a peak in mid October, touching just under $1,400.  Then, boom, down we went quite quickly to just over $1,300, a drop of almost 7% in two weeks.

Will that happen this time?

I have no idea, but it’s possible.  We could see a day or three of more pop to the upside, until the Big Boyz finally say enough is enough and squash gold back down.  Perhaps they let it run to $1,750, and then smash it back to $1,650 or so.

Of course they can’t hold it down for long, or forever, so any short correction will be yet another buying opportunity, just like it was all the way up.

So, here’s what I did this week:

I covered three of my blue chip gold and silver stocks, but selling short term, out of the money calls.

I covered RGL.TO – Royal Gold Inc. by selling the September 88 calls.  Royal Gold closed Friday at $88.56, so my out of the money calls are now in the money, which isn’t good.  (For those of you who aren’t following along: I own the stock, but by selling call options, I have given the purchaser of those options the right to buy my shares from me for $88 at any time up to the close of business on the third Friday in September, which is September 21, or two weeks from now).  So, if Royal Gold stays at $88.56, on September 21 I will be forced to sell my shares for $88, so I’m selling for 56 cents less than I could sell them for on the open market.  Bummer.

However, I sold the call options for $2 back on September 5, so I’ve got $2 in my pocket to mitigate my potential 56 cent loss.  From my perspective, as long as Royal Gold is trading at $90 or less on September 21, I break even.  If it drops below $88 my calls won’t be called, and I keep the $2.  The 52 week high is $89.73, reached intra day on Friday, so to hit $90 would be another new high.  I will sit and watch for the next two weeks; if there’s a drop, I’ll repurchase the calls I sold and pocket the difference.  If there’s a big drop I’ll let them expire.  If it goes on a run above $90 I’ll have to decide whether I let my shares go and buy them back later, or if I take the loss on the options and keep the stock.

I also covered SLW.TO – Silver Wheaton Corp. by selling the September 36 calls on Friday for 72 cents each, giving me a break even point of $36.72 over the next two weeks.  (With commissions it’s a $36.69 break even point).  Silver Wheaton closed at $35.60, so it’s got some room to run before my options are in the money.

Finally, I covered FNV.TO – Franco-Nevada Corp. by selling the September 54 calls for 75 cents.  The stock closed at $53.23 on Friday, so again, my options are out of the money, so I’m in a decent position.

The next two weeks will be interesting.  If the Bernank announces QE3, gold could shoot up, and I’ll be kicking myself for surrendering some of the upside.  However, on any dip, I’ve reduced my cost base, so given the recent run, it’s a risk I’m willing to take.

More next week.  Thanks for reading, and have a good week.

{ 0 comments… add one now }