Whatever happened to Gold?

Crude Oil is by far, today's most essential and indispensable commodity. The world would literally come to a halt if trucks, ships and airplanes powered by oil, could not deliver essential goods.

Gold on the other hand has been, since early times, a trusted measure of currency and a safe haven for traditional investors. We are by no means "gold bugs". We are reporting facts as would relate to any other investment. For our purposes, this article will look at how these markets move relative to one another.

With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.

What is the Gold/Oil Ratio: The Gold/Oil ratio measures the number of barrels of oil that equate to one ounce of gold. It is calculated by dividing the price of Gold by the price of a barrel of Crude. According to researcher Adam Hamilton of the Zeal Intelligence newsletter, the Gold/Oil ratio stood at an average of 15.3:1 for the 40 year period from 1965 to 2005. The range was as high as 33 with a historical low of 6.6. Looking at the December contracts for Gold and Crude Oil as of the close on 10/9/06 that ratio stood at 9.48 ($582.80/$61.49). Again this simply means that the price of Gold is 9.48 times the price of Oil.

With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.

This suggests that prices will eventually realign to a "fair mean". In this instance Gold should move higher unless, of course gigantic new deposits of oil are discovered and find their way to the marketplace rapidly - which is quite unlikely - causing the price of Crude Oil to drop.

In the late 1970s, Gold lagged oil eventually rallying up with to hit its all time highs of $850. Today, the scenario appears poised to repeat itself, however keep in mind that past performance is not indicative of future results. Even when Dec. Crude oil moved up to $76.90 on May 12, 2006, Dec. Gold went to $753.00 bringing the ratio to approximately 9.79:1. Based on the historical average of 15:1, Gold still appears undervalued relative to crude oil. Another factor affecting the price of Gold is the fact that the US Dollar has been trending higher as of late and the correlation between these two markets is negative, meaning that they have a tendency to go in opposite directions.

What will it take for Gold to get back to its historical ratio of 15:1?
Let's examine world events that could contribute to higher Gold prices:

• OPEC announced a 1 million barrels/day cut with the intention of maintaining Crude prices above $55.00/barrel; Demand for Crude oil prices is still growing due to expanding economies in Asia, notably China and India; Alternative fuels, though readily available, are years away from mass distribution; Energy efficiency has improved however demand continues to grow;
• N. Korea successfully accomplished a nuclear test and could potentially become a threat to peace in the region; Slowing real estate markets in the US along with growing consumer debt (up $4.99 billion in August according to the Federal Reserve) may cause the consumer-driven US economy to take a hit;
• China's central bank announced its intention to double its Gold reserves after already doubling them to 600 tons. If China were to increase its reserves to only 5% of its foreign exchange holdings, it would have to purchase an additional 1900 tons of Gold making it the 5th largest holder behind the U.S., Germany, the International Monetary Fund and France;
• The Financial Times reported that Germany's Bundesbank will halt its sale of gold reserves for the third year and other central banks worldwide have followed suit while others have beefed-up purchases;
• FT also reports that Italy and Ireland have not sold any gold in the past two years;
• Worldwide concerns over the US Dollar has many central banks alarmed over the currency risk associated with holding the Greenback;
• Russia, Argentina, South Africa, the UAE and several others are adding Gold to their portfolio as a way to offset their risk exposure in the US Dollar;
• The growing national debt in the US (the largest in the history of the world) is sending a message of unease to world economies who are fully aware that their economical welfare is highly dependent on a healthy US economy;

What To Do?
Looking at the chart above, we can see that Gold is clearly not in a bullish stance. Each time Gold has tried to go back up, it's made lower highs followed by lower lows; far from a bullish sign. We can see that since it made its high in May 2006, Gold has retraced back nearly 25%. Short term resistance is at $600 with longer-term is at $630. Support is at $555 and if broken could signal an extended down-trend. Although I am long term bullish on Gold for all the reasons listed above and more,

I believe that we'll see Gold trading in a range well into November at which time, growing demand should push prices back to the highs made in May of this year. In my opinion for the time being, it would be wise to be patient, look for an entry point once prices have established a clear uptrend and proceed cautiously when that time comes. This market carries a lot of risk and daily swings can be gut-wrenching.

Gold:On the move again By Chad Butler

After a brief hiatus, Gold is returning to my radar screen. With downside momentum in check and a successful hold of previous support, Gold may make that push to make a strong finish to this year. How can a trader take advantage of this market?

I find that a longer term focus using a trend following methodology works best for me. Ultimately, I use the 9 day simple moving average to tell me what the short term money pressure is on the market, and I look at the 50 day moving average to tell me what the long term money pressure is. If the 9MA is above the 50MA, the market is in a bullish stance, and I would look for buy entries. If the 9MA is below the 50MA, the market is bearish and I would be looking for an opportunity to sell.

Currently in Gold, the 9MA is about to move above the 50MA, indicating that we should be looking for buy entries. This is reinforced by the MACD. I use a 9/50 compression on the MACD to complement my use of the 9MA and the 50MA. In late October, we saw a MACD cross, indicating a shift of momentum to the upside.

The conservative trader should wait for a day in which the 9MA settles above the 50MA prior to entering the market. A more aggressive trader could be looking for entries now. But what are the possible trades?

When using the trend following methods that I use, I caution not to use the technical indicators (the moving averages or the MACD) as both a screening tool AND an entry tool. Rather, I prefer to use price action to determine specific entries and exits. The most conservative entry is to buy a breakout of resistance. In the case of Gold, round numbers are key psychological barriers and therefore make good points to watch for breakouts - 620, 630, 640 will be key. Also, a breakout above previous resistance is a good entry. The market is breaking out today, the next preciously tested resistance level would be the 648.50 level. I find 620 to be significant as well as it has been a previous area of support.

For more precision, one could wait for a setup using the 20 day exponential moving average. This trade setup occurs when the market pulls back and settles below the 20 day exponential moving average, then makes an attempt to regain the high of the day that settled below that level. The textbook trade is to buy the open of the following day. However, traders employing this technique are cautioned to wait for confirmation that we are in an uptrending market ( i.e. the 9MA has crossed the 50MA).

Alternatively, more conservative traders could employ option spreads in Gold. An option spread, such as a bull call spread, gives a trader the opportunity to participate in the market with a limited risk position (the risk on a bull call spread is limited to the cost of the position). The advantage to using a spread like this, as opposed to buying a call option outright, is that for similar cost, a trader can often get a position that is closer to the actual market price. The tradeoff in this trade is that the upside potential is capped at a maximum amount (the difference between the strikes).

Here is an example. A trader would purchase a 640 call February 2007 gold while simultaneously selling the 680 call. The 640 call currently has a theoretical value of approximately $1800. The 680 has a theoretical value of about $880. To construct a bull call spread, the trader buys the 640 call for $1800 and sells the 680 call for $880. The difference is $920. That is the net cost of the position and the maximum that the trader can lose on the trade.

But how much can he make? If Gold is trading at or above 680 at expiration (85 days from now), the position would be worth the difference between the strike prices. This is $4000. Take away the $920 that the position cost and the maximum net possible gain would be $3080. This is approximately a 1:3 net risk:reward ratio (1:4 gross). When constructing option spreads, I find this to be a reasonable number and I seek out trades that are at least 1:3 risk versus reward.

But what about the outright call positions? Well, for the same money as our spread trader, a trader would have to go to the 675 call in February 2007. The current theoretical value is approximately $966. But for that to be a better trade, Gold would need to be trading above 684.66 at expiration just for us to break even (675 strike + 9.66 paid for the call). To beat the call spread, we would need to be at $715.46. Now, if we were expecting gold to be trading well above that, the outright call would be our preference. But the call spread gives us a good look at the upside while keeping us in a limited risk position.

Certainly, for the trader willing to take the risk, the outright futures are trade to take. You get a 1:1 look at the market, while the market will have to make significant strides for the outright call or the call spread to benefit. But risk has to be considered with that. Traders looking to get long on either a breakout move, or on a 20EMA setup, a stop at key support would be necessary. For me, this is the 565 area. I would want my stop to be somewhere outside of that area, looking at 560. If the market clears and settles above the previously outlined resistance areas, the stop could be trailed behind accordingly.

I have outlined some broad trading examples here to take advantage of a building uptrend in Gold. But there are some caveats. First, if you do not understand the risks of any of these trades (or any trade for that matter), you are advised to do nothing until you fully understand and are comfortable with the risks. Second, these are some broad examples. They are geared to more intermediate to advanced traders that can work them into an already sound trading plan. If you lack a sound plan and the discipline to execute it, you would be wise to discuss a plan with a market professional prior to taking any action.

Metals-Snap Shots!!

Silver is a lustrous silvery metal extremely malleable and ductile: symbol Ag (Lat. argentum). Known since prehistoric times, silver occurs native in Peru, but the chief ores are sulpides, from which the metal is extracted by smelting with lead. It is the best metallic conductor of both heat and electricity, and its most important compounds are the chloride and bromide which darken on exposure to light, the basis of photographic emulsions. Silver is used for tableware, Jewellery, coinage, electrical contacts and electro-plating, and as a solder it makes good metallic joints at 720ºC. The world’s greatest producer of silver is Mexico (c. 40,000,000 troy oz. p.a.) followed by the U.S.A., Canada, Peru, the Russia, Australia and Japan.

Aluminium is the most abundant metal, valuable for its light weight, having at. no. 13, at. wt. 26·98, and chemical symbol Al. Nearly one-twelfth of the substance of the earth’s crust is composed of aluminium compounds, but aluminium in its pure state was not readily obtained until the middle of the 19 th century, for it oxidizes rapidly, and much energy is needed to separate the metal from chemical combination. Pure aluminium is a soft white metal. It is one of the lightest of metals, its specific gravity being 2·70, and for this reason is widely used in shipbuilding and aircraft. In the pure state it is a weak metal, but when alloyed with other elements such as cooper, silicon, or magnesium, alloys of great strength are obtained. Commercially, aluminium is obtained from bauxite (q.v) and requires large supplies of electric power, as at Kitimat in Western Canada. Aluminium is much used in steel-cored aluminium overhead cables and for canning uranium slugs for reactors. Aluminium is an essential constituent in the Alcomax series of magnetic materials; and as a good conductor of electricity is used in the form of foil in electrical capacitors. In the U.S.A. the original name suggested by Sir Humphry Davy Aluminum (aloo-) is retained.

Cooper is a chemical element, one of the earliest metals used by man. Chemical symbol Cu; at. no. 29; at. wt. 63·54. It is salmon pink, very malleable and ductile, and used principally on account of its toughness, softness, and pliability, high thermal and electrical conductivity, and resistance to corrosion. When alloyed with tin it forms bronze, a relatively hard metal, the discovery of which opened a new age in human pre-history. Until about a century ago, Spain and Cornwall were the chief producers, but these are now of minor importance compared with the U.S.A. (which produces about a quarter of the world’s output). Chile, Canada, Zambia, and the Katanga area of the Congo. Cooper is usually commercially extracted from cooper pyrites. Large deposits containing cooper sulphide occur in the Lake Superior district in North America, and in Spain. Other ores from which cooper is extracted include malachite, crysocolla, and atacamite.

Gold is a heavy, valuable, yellow metallic element, with symbol Au, atomic number 79, and atomic weight 197·0. Gold has long been valued for its durability, malleability, and ductility, and because it may be easily recognized. It is unaffected by temperature changes and is highly resistant to acids. Its main uses are in coin and jewellery. South Africa produces almost 75 per cent (30,500,000 fine oz. p.a.) of the world’s gold and other major producers are the Russia, Canada, U.S.A., and Australia. For manufacture, gold is alloyed with another strengthening metal, fineness being measured by the parts of pure gold in 24 carat.

Nickel is a lustrous white metal discovered by Cronstedt in 1751, the name being an abbrevation of Swedish kopparnickel (false cooper): symbol Ni, as. wt. 58·71, at. no. 28. It has a high melting point, low electrical and themal conductivity, and can be magnetized. Nickel may be readily forged when hot, and is though, malleable, and ductile when cold. Canada provides the most extensive deposits, which are usually extracted with cooper. Smelting precedes separation, after which the Nickel is purified. It is used in coinage; in chemical and foodstuff industries for its resistance to corrosion; in electronics and for electroplating. The most important use, however, is in alloys with iron, steel, cooper, and chromium, incl. Nickel steel for armourplating and burglar-proof safes, Moneal metal, invar, constantan, nichrome permalloy, perminvar, and other magnetic alloys and stainless steels, cupro-nickel, nickel-silver, and others. Finely divided nickel is used as catalyst in the hydrogenation of vegetable oils.