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Gold stocks rally on PPI data

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Gold stocks are this morning's sector winner as a stronger than expected PPI number has inflation bugs snapping up some gold stocks. In this morning's "market monitor" on OptionInvestor.com I thought this might be the place for a trader to be looking on the bullish side, but right now my outlook would be short-term in nature. Here's why.....

I'm watching the December 2001 Gold Futures contract (gc01z) and action here is not as bullish as I think it should be for today's 4.36% jump in the Gold/Silver Index (XAU.X), which is a basket of stocks (key word is STOCKS). Just after the terrorist attacks, I wrote a sector spotlight on gold stocks and explained the difference between price action there and what the futures contract would tell us as it relates to the underlying commodity. My thought were that the futures contract was perhaps a more accurate measure of the MARKETS perception on Gold as a hedge. After all.... a stock is a stock and not necessarily gold bullion (this was more thoroughly explained).

With the difference understood, lets take a look at the gold futures contract and try and get a feel for what the market may be saying about the commodity itself. Yes, the futures contract is just a piece of legal paper, but it represents the commodity.

December Gold Futures Contract (gc01z)

No real signs that the market is overly worried about inflation today. A modest gain of 0.14% to $283/oz. right now. Note how this contract shot higher to the $293 level immediately after the terrorist attacks. Remember how we were watching foreign currencies at that time also show strength vs. the US$? The last three session, not long after the U.S. launched attack on Afghanistan positions, the gold futures fell and yesterday came right down to a level of technical support. With today's PPI data, I would have though gold bears would have rushed in to cover some positions at the $281 level as PPI data could have spelled of inflation (inflation worries often times causes gold to rise in price as a perceived hedge against inflation). Note how the above gold futures chart jumped from $275/oz back in May to over $300/oz. That was based on worries of inflation!!!! No terrorism back in May. Right now, we're seeing little reaction on the commodity side to today's PPI number and this should have bullish traders in gold stocks somewhat short-term bullish, but that's it. If you're a bullish trader in gold stocks, then keep an eye on the December gold futures. An equity bull in gold wants to see gold futures start heading higher from here and hold above the $280/oz level.

Every traders/investor can follow this too! I've said before you don't have to be invested in or trading in everything we talk about, but many of the things (like gold) give us some insight into what the market is thinking. While today's PPI number was a surprise, the futures market doesn't look like it is all that concerned, or at least we're not seeing a rush to buy the futures contract on the belief that gold will surge due to inflationary pressures. However, a move much above the 286 level could have the market thinking differently.

So why did I profile gold stocks as a potential bullish play in the "market monitor?" Because I believe that stocks often move in advance or help "predict" the future. By watching the futures, I can then look for confirmation. If after some time passes, I'm not seeing any confirmation from the commodity, then its time to make a decision. If I've properly assessed risk/reward in my trade beforehand and have a scenario in place to test against, then I can make a much better and well-informed decision. If a trader becomes profitable in a trade, but doesn't get confirmation of his scenario, then doubt begins to set in. At that time, we draw on the old trader/investor saying... "When in doubt get out!" If you've got a profit, the decision then becomes that much easier.

Jeff Bailey
Senior Market Technician
Option Investor

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