A Bullish Case For Gold: Follow Up

Includes: GLD
by: Damir Tokic

We previously (Feb 18th) presented a bullish case for gold (NYSEARCA:GLD) primarily based on these two facts: 1) the federal funds futures were not pricing the economic recovery any time soon - at the time the federal funds rate was expected to increase to 50 basis points in May of 2015, and 2) the long term technical chart of gold was showing a rising bubble that had not peak yet. Since Feb. 18th, the price of gold has dropped below $1600, fast approaching the major long term technical support of around $1520. What has changed since Feb. 18th? Fundamentally, nothing has changed. The federal funds futures are still predicting a 50 basis point hike in interest rates by the Fed in May of 2015, more than 2 years from now! However, technically things are starting to change. We are approaching the major technical support level of $1520, and if this support is broken with increase in volatility (based on gold VIX), we can potentially have a bursting bubble in gold.

Some managers have publicly expressed their opinion that fundamentally gold is a buy at these levels, and any further drop is only an opportunity to buy more gold, irrespective of technical analysis. Are these managers wrong for ignoring the technical analysis? We believe yes. If gold breaks the major technical support level, we are likely to see a heavy selling, which could bring gold to below $1000 quickly, as the bubble bursts.

But what about the fundamentals? The price of gold could be leading the fundamentals. We could see a change in the federal funds futures after the gold bubble bursts, in which case, we would have a bursting gold bubble and deteriorating fundamentals for gold. In other words, a string of better than expected economic data releases (after the gold bubble burst) could cause a prediction that the Fed would start a cycle of rising interest rates much earlier than currently expected, which would be a clear negative for gold prices. Perhaps gold prices are reflecting this expectation.

However, fundamentally we are still bullish on gold here, but we would not advice buying gold futures or right now due to deteriorating technical picture. We reiterate that the best way to play gold right now is by buying long term call options on gold futures and, for example Dec. 2200 calls. But also, since the gold volatility is still very low, based on gold VIX, it might not be a bad idea to buy some gold puts, for example June 1200, just in case there is a gold bubble burst. Thus, the best opportunity in gold now is the low volatility Gold VIX, which is likely to significantly increase.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.