Why the Gold Rush Is Out of Steam and How to Respond

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 |  Includes: AA, CAT, GDX, GLD, IBM, SLV, UGL
by: David Alton Clark

Over the last two years Gold is up approximately 60 percent, rising at a steady pace. Gold has risen from around $900 two years ago to an intraday high of $1577 May 2, of this year. Since that date Gold has dropped to $1494 as of July 1. This is a precipitous drop of approximately six percent in the last two months. See the chart below.

Two year Gold Chart - (click charts to expand)
Click to enlarge

Although Gold has risen 60 percent over the last two years, it has only gained approximately 4 percent over the last six months. Can you say… running out of gas? Over the last two months Gold has dropped to $1494 as of July 1. This is a precipitous drop of approximately six percent in the last two months. The down trend in Gold was confirmed recently by the charts. Gold has broken below the 2011 uptrend line of $1542 and below the 50 day moving average line of $1520. This short term trend change to a downward trajectory appears to be mirroring the Euro/Dollar chart. Gold could find support at the 200 day moving average line of $1420, but if it breaks significantly below the 200 day moving average look out below. See chart below.

Gold YTD Chart
Click to enlarge

Current Market Conditions

It seems we're about to have a tectonic shift in global macro-economic conditions with the end of the Fed’s QE2 easy money program and the inevitable default by the Greeks. Greece will drag the rest of Europe to the bottom of the Mediterranean sea, and the Euro along with it whilst the dollar rises. The renewed strength in the dollar will reduce the value of gold. It is only a matter of time before the big run up in the GLD unwinds even further. It seems the Silver ETF (NYSEARCA:SLV) has already begun to unwind. The SLV has had a torrential drop from a high of nearly $50 to the low $30s in a matter of days. Sell the GLD and buy a basket of the following DOW stock value plays.

Thursday June 30th marked the end of a $600 billion bond-buying program by the Federal Reserve. The QE2 program had little effect on the country's employment position, but the market's QE2 rally rose to rival multi-year heights by the end of the first quarter this year. The Dow was up 28 percent over this period. The leaders for the exchange were: Caterpillar (NYSE:CAT) 61.6 percent, Alcoa (NYSE:AA) at 58.00 percent, and IBM (NYSE:IBM) 38.9 percent. These three DOW stocks have great stories and positive catalysts for future growth and PEG ratios of less than 1. The PEG ratio is a broadly used indicator of a stock's prospective worth. It is preferred by numerous analysts over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued. Many financiers use 1 as the cut-off point for PEG ratios. A PEG of 1 or less is believed to be favorable. These are bullish indicators regarding a stock's possible future performance.

Moreover, Joe Terranova recently stated regarding the equities market’s future, “Rotation will drive the S&P. I expect to see money come out of Treasury’s and into stocks. As we enter the new quarter portfolio managers are on the edge of their seats, because they’re under-invested in equities.”

Conclusion

I am recommending you buy these three Dow stalwarts, which are significantly undervalued with great prospects for the future - and sell or significantly reduce your exposure to gold ETFs, specifically the SPDR Gold Trust (NYSEARCA:GLD), Market Vectors Gold Miners fund (NYSEARCA:GDX) and the ProShares Ultra Gold (NYSEARCA:UGL).

As for the icing on the cake, investing guru extraordinaire Warren Buffett famously said,

"Look, you could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all - not some - all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

Based on the current market conditions I would suggest scaling in to any position to reduce risk. I believe all these stocks are currently undervalued and provide significant opportunities for long term investors. Please use this information as a starting point for your own due diligence.

Information was sourced from CNBC, Yahoo Finance and respective company websites.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AA, CAT, IBM over the next 72 hours.