Flags In Gold: Which Way Will The Wind Blow?

| About: SPDR Gold (GLD)

This is a big week for gold. With fully formed flags on the Weekly and Daily charts as well as three successful bounces off the Weekly 100DMA, we have a reached a do or die time for Gold (NYSEARCA:GLD)

GLD Weekly ChartClick to enlarge

As you can see on the weekly chart for GLD, we've seen a strong downtrend since September of last year. This was broken for a brief time in February but we saw a quick reversal and resumption of the downtrend. At the same time, you can see that the 100DMA has been providing consistent support for gold. Three times we saw a test and bounce with the last one providing enough momentum to break out of the downtrend and flag that had formed. On Monday alone we have already seen a test of the of downtrend from the upside and what was once resistance appears to be support.

Also, you will notice a bullish MACD cross on the chart that helped push us past what has in past proven to be very strong resistance. This should provide additional strength going forward as the MACD heads towards positive territory.

GLD 6 Month Daily ChartClick to enlarge

On the daily chart we see the same flags but on a shorter time scale. The February test and rejection was one day's worth of action (Excellent work Blythe!) and the resultant downtrend started forming a flag in May. Once the markets were back in turmoil we started seeing more demand for the physical insurance that can be found in precious metals.

Again, we see an upside break of the downtrend in the last few days' worth of action but the February collapse should provide us with pause before declaring victory.

What Lies Ahead

With a technical breakout and some bullish indicators, we should be in the clear for the next leg up in gold. This week should prove to be key in determining the future course. Bernanke and the FOMC will be guiding the near-term future for the dollar on Wednesday. If they announce LSAP of any kind while maintaining the ZIRP 2014 target, we should see a continued spike in gold as the dollar declines in the market. However, if they go with no LSAP and just an extension of ZIRP to 2015, we would see a much smaller run up in comparison. Bernanke could always go with jawboning and further communications but the market has by now priced in at least one of the above scenarios, if not both.

Even if Bernanke disappoints, we could see a complete reversal based on Draghi and the ECB on Thursday. With 10 year yields in Spain still well above 6% and Italy still on the brink, he is going to have to come through with something substantial at this meeting. A simple rate cut or a small LTRO is not going to cut it when you promise to do "anything it takes to maintain the euro". While I put good odds on the ECB announcing something substantial, we could just as easily run into more jawboning which would take gold back below the line of resistance.

Compared to these two events, the Non-Farms Payroll announcement on Friday pales in comparison but should not be completely discounted. By 8:30AM on Friday, the markets should have already picked a direction based on the FOMC/ECB decisions and the NFP number could add momentum either way. If the jobs picture is better and LSAP is already announced both here and abroad, that should add to the euphoria. If the opposite, it will only add to the negativity.

How to Play It?

Since we can't determine the direction, but can expect a large move regardless, this is a textbook opportunity to attempt a strangle on GLD using options.

To avoid a complete collapse in implied volatility, we would want to start the position today with August 18 options and look to unload prior to the FOMC announcement on Wednesday at 12:30 PM.

Using the flags as a reference point, I would put a move below the Weekly 100DMA by buying the $152 Put and buy the $162 Call for a pop higher.

Aug 18 $152 Put: 0.67

Aug 18 $162 Call: 0.91

The total cost for the straddle would be $1.58 and would require a move below $150.42 or above $163.58 to break even at option expiry. Since we are looking to unload this strangle well prior to that date, we are more interested in the gains we make in implied volatility prior to the announcement. If the trade is profitable at 12:00PM on Wednesday, I would exit it and book profits. No matter what, I would not recommend holding it past 12:30 as the implied volatility in the options will collapse as the market tries to find a direction.

Once Bernanke starts speaking at 2:15PM, the market should be in the midst of finding a direction again and could easily reverse the move seen in between the announcement and the bearded wonder press conference. The implied volatility should have leaked out substantially at this point and one can either re-enter the strangle if an obvious direction has not appeared, or pile into the Weekly or August options that best fit the price action.

Gold tends to trade in the same direction for 2 days in a row after FOMC meetings, so we could see the same move again on Thursday, depending on what Draghi does to the markets and Friday, depending on NFP. The easy money would be a play on the run up prior to the FOMC announcement, and then riding the bandwagon once a direction is established later in the day.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.