Bounce In Gold Is A Dead Cat - Fade The Rally

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Includes: GLD
by: Sam Kirtley

Gold prices have enjoyed a welcome bounce from $1200 to $1280 recently, which has some perma-bulls bringing out the famous "this is the bottom" LP yet again, a record which has been played so many times this year it must be getting close to wearing out. Whilst this minor bounce in gold is to be expected with Bernanke cooling the market's aggressive tapering expectations, a major rally is not sustainable, since the Fed is not embarking on any new quantitative easing in the foreseeable future.

As such we view this to be a dead cat bounce and, having taken profit on our previously aggressive short position on gold, we will be looking to fade this rally and accumulate short positions on this temporary bounce.

For those readers not familiar with the "dead cat" concept, it describes a temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. An old proverb says, "Even a dead cat will bounce if dropped from high enough", but just because it bounces that does not mean it is alive. This applies to the gold bull market; just because we are seeing a minor bounce, that doesn't not mean that the gold bull market is alive - make no mistake, gold is toast and will continue to head lower.

Technically the bullish crossover on the MACD could see gold prices push higher in the short term, which we would welcome, since it provides better levels to enter short positions. To the topside $1350 is the full extent of where gold prices could get to, but we doubt gold has the fuel to get there.

Let us not forget that just a week ago we had some very solid US employment data, and as the chart below shows this is a continuation of a trend we have seen for nearly a year now. This sustained improvement in the employment situation has eliminated the possibility of more QE from the Fed and buried the gold bull market.

Predictably gold mining stocks have continued to fall further into the abyss, and, even on this recent bounce in gold prices, have not been able to rally. Whilst we think gold mining stocks still have further to fall, we are waiting for a better opportunity to take short positions on the plagued miners.

Unfortunately the industry has been left un-hedged and over leveraged after a decade of rising gold prices, with many companies paying over the top for new mining prospects, which will not be producing gold for many years, when the price will likely be much lower.

With US equities rising, there is a chance gold miners will get dragged higher, however this has not occurred thus far in 2013.

We are bullish on US equities and think the S&P 500 is heading to 1800. The bullish sub-zero crossover on the MACD was our signal to enter long position on the index, which we did via an options trade last week that is currently up 20%.

Dips in the S&P 500 are to be bought, rallies in gold, silver, and associated mining stocks are to be sold. That is our trading strategy in the simplest of terms. To conclude, we would like to emphasize our point that this is a dead cat bounce in gold, and nothing fundamentally or technically has changed materially. Gold is en route to $1000, and we consider the risk-reward dynamics in shorting gold at these levels to be attractive, and above $1300 to be very attractive indeed. It is important to keep the big picture in mind; gold is far more likely to go to $1100 than to $1500, therefore one should be short gold with a medium and long term outlook, since the next $200 move is down.

Disclosure: I am short GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short GLD via a combination of option positions.