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Gold (NYSEARCA:GLD) is now very attractively positioned for traders (and investors) with bullish and bearish positions alike.

Technically, the bulls see a strong long-term uptrend, which is still intact, and view the recent price action (since the peak of September 2011) as a healthy consolidation before the uptrend continues. On the other hand, the bears see the potential bubble in gold with significant downside once the technical support is broken. Thus, technically speaking, both the bulls and the bears are playing a classical bubble-game, which can be notoriously volatile.

Fundamentally, the bearish case for gold is based on a prediction that the global economy has survived the financial crisis, and thus buying gold to insure against the doomsday-scenario makes no sense. The bulls, on the other hand, don't really agree that "we are out of the woods yet," frequently referring to the global currency wars, and the continuing QE by the Fed.

Our research shows more support for the bullish case for gold based on the two facts, one fundamental and one technical. First, fundamentally, the Federal Funds futures are currently predicting that the Fed will increase the interest rates to 50 basis points in May of 2015! (Figure 1) As early as December 2012, the prediction for the Federal Funds rate in May 2015 was only 30 basis points (Figure 2), which is not meaningfully higher from the current level of 14 basis points. Essentially, the Federal Funds futures imply no real end in sight for the current crisis over the next 2-3 years, and that's a fact. Yes, the chart in Figure 1 looks steep, but selling gold now, based on the possibility of "baby-step" increases in interest rates 2-3 years from now, does not make much sense. Technically speaking (ignoring the fundamentals), the long-term chart of gold futures resembles a rising bubble, which has not peaked yet. History shows that bubbles usually end in panic buying and exhaustion, followed by a bubble bust. The price of gold has been consolidating for last 18 months since the peak, and that's also a fact (Figure 3). Thus, we did not have a classical bubble top in gold, which will likely occur at much higher prices.

In summary, fundamentally the bull market in gold still has room to run, strictly based on the current economic forecast embedded in the Federal Funds futures. Technically, the gold bubble has not peaked yet. As a result, we believe that gold is about to enter the last stage of a long term bull market, possibly characterized by a parabolic rise. The return to risk-on strategies will have negative consequences for the broad stock market (NYSEARCA:SPY) as well.

Our specific recommendations:

We suggest that traders buy longer-term call options on gold futures or GLD. Specifically, we are looking at Dec 2013 call options on gold futures, strike prices 2200 and 2300. These options cost $610 and $320 per contract, respectively (as of Feb 15th). This is not only a directional bet on rising gold prices, but also a bet on the rise in volatility, which is at near record low levels, based on the gold VIX index. Thus, even a bounce of gold prices to the resistance level at around 1800 would likely triple the prices of these call options as the volatility increases. We are looking specifically at Dec call options to minimize the risk of premium decay due to time expiration. This strategy also has a predetermined maximum loss in case we are wrong, which is desirable in a bubble-like environment.

Figure 1. Federal Funds rate implied from Federal Funds futures (source CME).

PriceRate
February 201399,860,14
March 201399,860,14
April 201399,860,14
May 201399,860,14
June 201399,860,14
July 201399,860,14
August 201399,860,14
September 201399,860,14
October 201399,8550,145
November 201399,850,15
December 201399,8450,155
January 201499,840,16
February 201499,830,17
March 201499,820,18
April 201499,810,19
May 201499,7950,205
June 201499,7850,215
July 201499,770,23
August 201499,7450,255
September 201499,7250,275
October 201499,7050,295
November 201499,6750,325
December 201499,660,34
January 201599,6350,365
February 201599,590,41
March 201599,560,44
April 201599,5350,465
May 201599,5050,495
June 201599,4750,525
July 201599,450,55
August 201599,40,6
September 201599,3650,635
October 201599,330,67
November 201599,2750,725
December 201599,2350,765
January 201599,190,81

Figure 2. Federal funds futures - the Fed rate equals 100 minus the price (source CME)

Figure 3. Gold futures prices (source CME)

Source: A Bullish Case For Gold: Let The Facts Speak