Downside Ahead For Gold?

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Includes: GLD, GLL, GTU, IAU, OUNZ, PHYS, QGLDX, SGOL
by: Wall Street Daily

By Jonathan Rodriguez

For months now, the correlation between stocks and crude oil has been discussed ad nauseam.

Excluding the energy sector, the S&P 500 index typically moves inversely to the price of "black gold." When oil goes up, stocks go down, and vice versa.

However, an interesting scenario has unfolded over the last few months: Stocks have moved right alongside crude.

In fact, January saw the tightest correlation between the two (96%) in a decade.

This coupling is due to a number of speculative factors: fears of a global slowdown, fears of oil producer defaults - basically, fear.

And oil isn't the only commodity coupling with stocks, either. Indeed, there's another, even juicier, fear-driven correlation taking place...

The Long and Winding Yellow Brick Road

The commodity in question is none other than gold, which has enjoyed a colorful relationship with the S&P 500 over the years.

The S&P tracks gold inversely, just as it does with oil. Basically, when stocks tumble, investors run for safe havens: Treasuries, utility stocks, and gold.

But when stocks rally, gold falls. That's because, on a total return basis, stocks outperform gold handsomely.

Gold Tanks as Stocks Advance: Gold vs. S&P 500 Five-Year Chart

The S&P 500 gained 112% from its 2011 low to its 2015 high, including dividends. Conversely, as stocks have stormed up the chart, gold has been locked into a long-term downtrend - off 44% from its 2011 peak to its 52-week low.

Yet, there have been plenty of opportunities to profit on the metal when stocks stumbled.

In 2008, the S&P 500 finished the year down 38%, while gold gained 1%. When stocks tumbled 14% in the summer of 2011 on eurozone worries, gold gained 11%.

And most recently, gold rose 5% last August, while stocks fell 11% on China concerns.

Profit on Gold's Momentum Shift

Let's fast-forward to 2016. The S&P 500 is down 8% year to date, and gold is up a whopping 12%.

Now, you may recall that I profiled a mining stock poised to take advantage of gold's long-term upside last week. But if we view gold from a technical perspective, the metal can be a reliable short-term momentum play for bulls and bears.

A trader can simply get long gold when stocks are in a downtrend and take the short side of gold when stocks reverse the trend. Right now, stocks are deeply oversold and gold is heavily overbought.

Follow the Yellow Brick Road: Two-Year Gold Trend Channel Reveals Potential Bearish Reversal

As you can see, on a weekly basis, gold has traveled within a well-defined trend channel.

You can consistently play the side of long gold when it hits the lower bound of the channel through an exchange-traded fund like the SPDR Gold Trust ETF (NYSEARCA:GLD) or the iShares Gold Trust ETF (NYSEARCA:IAU).

However, gold is trading just below the upper bound of the channel right now, meaning a downside reversal is likely in the short run.

In fact, two key momentum indicators are already signaling a momentum shift.

First, gold has a relative strength index (RSI) reading of 79. This oscillating indicator measures a security's momentum over a rolling 14-day period on a scale of 0 to 100. Any RSI reading over 70 indicates overbought conditions and signals the possibility of a near-term reversal.

A stochastic reading on gold is also signaling a reversal. This indicator measures momentum using a security's high-low trading range over the last 14 periods. Gold's current stochastic reading is 90, well above the overbought threshold of 80 for this indicator.

So, how can we play the downside here?

Consider the ProShares UltraShort Gold ETF (NYSEARCA:GLL), which seeks to deliver twice (2x) the inverse of the daily investment results of gold bullion. The fund has $62.5 million in assets under management and a low expense ratio.

Because GLL uses leveraged futures contracts to achieve its returns, it shouldn't be held long term. Otherwise, traders risk price decay. It's perfect for taking profits on short, sharp moves to the downside over the period of a few days to a few months.

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