Does the Rally in Gold Reflect the End of a Bear Market Bounce?

April 8, 2009 | By | Reply More

Looks like the recent rally in stocks is over as markets react to gloomy forecasts for the current earnings season reports, kicked off by Alcoa (AA) worse than forecast losses for the quarter.

Tuesday’s New York close saw spot gold rally to $884 an ounce a rise of $12 from the open. Wednesday’s Asian trading sustained the rise while at 10am GMT in Europe the price had risen to $888 an ounce.

To us, this rally in gold reflects the end of the bear market bounce we have been witnessing during the last week or so.

As is the usual case, silver followed suit and ended firmer at $12.34 an ounce.

We are told by our favorite technical guru that the charts are painting somewhat obscure, even contradictory, pictures for the near term outlook for both metals.

What we see is that the underlying support remains in place as investors appetite for risky stocks diminish and return to the safe havens of precious metals.

The yet to be approved IMF sale of 403.3 tonnes of gold does not, in our opinion, pose a significant threat to the gold price but the sale of scrap gold and the fact that India, the world’s largest consumer has, for the first time in years, stopped importing the metal for the last two months, is a concern.

These last two indicate that the credit crunch is taking its toll as people worldwide struggle to meet their living costs and that demand for gold jewellery is slumping.

With that thought in mind we came to the conclusion that, while there was no strong reason yet that our belief in the longer term bullish future for both metals should be eroded, silver is indicating some more interesting shorter term prospects.

The gold/silver ratio is hovering between 68% and 70%, still high, and the silver market tends to show bigger percentage moves than gold, particularly when the metal prices are rising.

Add the fact that over 60% of total global supplies of silver are taken up by industry together with declining base metal mining activity, where silver production is a by- product gives a little ‘insurance’ not shared by gold, particularly if the many analysts prediction that recovery will evident by the fourth quarter or first quarter of 2010 proves correct.

Oops! We nearly forgot to factor in the inflationary scenario that we anticipate.

Our reaction was to look at call options for the iShares Silver Trust (SLV) where we found the July15 call trading at 50 cents ask.

We succumbed to the temptation on the basis that we do not expect silver to fall, at worst, much below $12 an ounce in the next three months, and that a more likely outcome is a return to over the $14 seen a few days ago.

Finally the take off in gold and silver that we expect to happen sooner or later, may just go into orbit before the July expiry date.

We would probably have baulked if the option price had been over $1 but the low cost of the gamble was irresistible. When trading options we always look for a low cost entry for starters before going through our analysis routines.

The option route is a great temptation as the leverage gives such great profit opportunities but they are dangerous for the unwary player, decay being the overriding factor to consider.

At pocket money prices, less than a modest bet on a horse race, they can give you a winner at an outsider’s odds if you do the maths and research.

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