Gold Forecast: A 30% Pop, Then Another Plunge

StreetAuthority Network

"You got to know when to hold 'em, know when to fold 'em." 

Kenny Rogers' "The Gambler" earned the silver-bearded singer a gazillion dollars and carried him on to fame and fortune as a rotisserie chicken magnate. But when it comes to trading -- especially when it comes to trading gold -- it's really darn good advice.

Now, as I wrote a few months ago, I'm no fan of the shiny yellow metal. But after a merciless pounding this summer, gold is due for a near-term rally. The best way to play this bounce is through the SPDR Gold Trust ETF (Nasdaq: GLD). The weekly chart explains it all.

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After blowing through $170 around this time last year, GLD has taken a nasty tumble of over 30%. Apparently, the fear trade can be scary on both sides of the table. When shares pierced $120, they bounced nicely by 18% -- and immediately proceeded to give most of that gain back. However, looking at the chart, it seems that a double bottom is in place for GLD.

Typically (and technically), a double-bottom formation can be a bullish signal. Besides the chart, there are some fundamental reasons the gold tracker is due for a pop -- at least in the near term.

Debt-Ceiling Follies
The recent debt-ceiling fiasco in Washington inspires even less confidence among financial markets and investors -- and especially goldbugs. This pushes up the price of the physical metal the GLD exchange-traded fund holds, thus pushing up the share price of the ETF

Even though a temporary deal on the debt ceiling has been reached, U.S. politicians are experts when it comes to kicking the can down the road. Expect the monkey business, fear and volatility to continue. As long as it does, the price of gold and the ETF tracker will creep up.

Hedge Fund Movers
Despite the conventional wisdom, most hedge fund managers are far from knocking it out of the park this year: The average hedge fund is up only about 3.4% while the S&P 500 Index is up better than 20%. As the year comes to a close, some hedge fund managers are scrambling to justify their 2-and-20 management fee structure to their investors. One of the best ways to do so is to trade an extremely volatile asset class. 

These days, gold fits that bill, and the quickest, most liquid way to trade gold is through gold ETFs like GLD. Watch for them to move massive amounts of GLD shares around, and ride their coattails when they do.

Don't Fight The Fed
In my July article, I argued that gold has topped and that as long as the Federal Reserve keeps the quantitative easing pedal to the metal, interest rates and inflation will stay low. This gives gold no reason to go up in value. Although outgoing Fed Chairman Ben Bernanke hinted that the Fed may begin to dial back its bond-buying program, don't look for anything significant anytime soon. 

Recently, I had a conversation with the head mortgage guy at a small bank. His firm originates high-quality mortgages and then, like any good mortgage bank, sells them off to bigger institutions. He thinks the that while the Fed will most likely scale back its purchase of Treasurys, it will continue buying mortgage securities until the U.S. housing market recovers. 

Turn Out The Lights?
So is the fun over for gold? Looking at the chart below, it looks as though, long term, GLD has put in the first half of a classic "head and shoulders" top -- so there's one more "shoulder" to go. Expect the price of GLD to give up 40% or more over the next few years.

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But there is some money to be made as a trade in the near term. The level at which GLD is oversold indicates a decent bounce is on the way.

One of my primary reasons for avoiding gold as a long-term investment is its lack of income production. In fact, if you're storing it in a safe deposit box, you actually have a negative cost of ownership. One way to combat this shortcoming is the use of covered call options on long GLD positions. (My colleague Amber Hestla has written extensively about this strategy.) 

Another idea is to own shares of the Market Vectors Junior Gold Miners ETF (Nasdaq: GDXJ). This ETF, pays a dividend of about 2%, owns a basket of stocks in actual companies, which usually move in tandem with the price of the metal. 

Risks to Consider: Remember, gold is a highly volatile asset whose price fluctuations are governed by many unpredictable external factors and events.

Action to Take --> GLD shares currently trade around $120. Look for near-term volatility to push the price up to around $160, close to the all-time high near $170. That would constitute a gain of 30%. After that, all bets are off. Remember to set price targets on both the upside and downside.

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