Option Investor
Educational Article

Is the War Over\?

Printer friendly version

Is the War Over?

Wait, last I checked, it hadn't even started yet! What on Earth might cause me to think the War (that hadn't yet been declared) was over? Why, the drastic fall today in the price of gold, of course.

"Great, Buzz. Connect the dots for us, won't you please?" With pleasure! Two weeks ago, Fundamentals Guy was on a rant about the shallow sound bites (often espoused by media celebrities parading as experts) on why the price of gold was moving up. Their five- second explanation usually contained a variant on the War with Iraq theme - "Investors bid up the price of gold today on stepped- up war jitters. . .", or "Gold gave up ground today as tensions eased in the Middle East. . ." or some other such nonsense.

As F.G. noted two weeks ago:

"Gold is also presumed to be rising and falling on investors' moods regarding an Iraqi war and the War on Terror. When uncertainty is thought to eventually lead to conflict, common wisdom is that 'fraidy cats and the delusionally paranoid will buy gold, and that that must be the reason we've seen the price rise in recent months. Similarly, common wisdom also states that when war jitters ease, the paranoid leave their mountain huts and revert back to a diet of speculative stocks and 110% equity financing to assimilate with society. Gold is for kooks."

So has that relationship changed? Perhaps the ups and downs of War prospects really don't matter much in the price of gold after all? Well, based on today's news of Britain and the U.S.'s frustration with France, China, and Russia's potential veto of any newly proposed resolution giving Iraq their 15th "one last chance" to disarm, which gives the 90-nation coalition in support of the U.S the impetus to do something or get off the pot (do something being the likely outcome), and that gold dropped overnight like it's dense cousin, the proverbial lead balloon, to $332 while still managing a close at just over $334, that relationship seems pretty rickety. Clearly increased war tension has little or no bearing on the price of gold. Were it true, the price of gold should rise when the TV cameras pan to see Blaire, Bush and Saddam Hussein in a loving group hug, an equally preposterous Hallucination in my opinion.

In short, the gold price/war relationship doesn't seem to exist.

So what happened that would cause gold to hit the skids so hard overnight?

Back up two paragraphs. What if the preposterous were to happen in secret? What if the U.S. was actually negotiating a "secret surrender" of some sort with Iraq? Crazy, I know, but play along for a moment. That would put a truce to a war that never officially started, and the world would breath a lot easier as tensions melted. Gold would sell off.

Simultaneously, that would cause the Dollar to gain strength against other currencies, as the U.S., Britain, and 88 other countries would not have a big a borrowing requirement to finance said war, and thus, would decrease the size of previously assumed deficits. With that in mind, the U.S. stock market becomes instantly attractive once again, as bonds sell off. Wow! And look what happened today! Are the markets telling us that Iraq is about to surrender?

Don't bet on it. However, the rumor of such was actually top-of- mind scuttlebutt in overseas currency markets last night, which was presumed to have Dollar-denominated shorts covering their positions, and thus, driving up the Dollar against the Euro and the Yen. A surge in the Dollar was very likely the culprit for the decline in gold. . .all likely sparked by a "surrender" rumor.

Short-covering born of the surrender rumor may very well explain the reason too that we saw amazing gains backed with significant volume in today's U.S. equity market, although the equity move had some technical chart backing too. I can only call today's equity action as significant short covering. Will it continue tomorrow? I can't say. But I believe it will trip bulls back in only to embarrass them again in the near future.

Maybe I'll be the one embarrassed. Like I said, I am no guru and I am often led to incorrect conclusions.

Be that as it may, rumors can get legs of their own, and right or wrong, can cause some pretty wacky price action in defiance of rational minds. As Keynes (I think it was Keynes) said, "Markets can remain irrational longer than we can remain solvent."

The point is that I personally believe the "surrender" is not real and that optimism is misplaced. I also think that we came much closer to a buying opportunity in the price of gold. F. G. wants to stress though that that is only with regard to price. An immediate rebound from this level will likely take some consolidation to allow the 50-dma ($356) to play a bit of catch-up with the 200-dma ($330). There is still a pretty big disparity that I think needs closing before we see another set of significant gains. How long that is, I can't say. After all, I'm not a guru! Aside from some quick price prints into the negative side of $330, I would expect $330 - the 200-dma - to hold as support.

But to identify the misplaced optimism noted immediately above, we need only turn to today's economic news in the U.S. Prior to 8:30 ET this morning, markets were expecting a 0.5% DECLINE in retail sales. The actual reported figure was a DECLINE of 1.6%, more than three times the expected decline. I am convinced that the U.S. consumer is in the process of shutting his/her wallet. The declines were broad-based in cars, furniture, building products, appliances, clothing, entertainment, and surprisingly, groceries. What, we've all stopped grocery shopping and gone on a collective weight loss diet?

Financially speaking, that isn't so far from the truth, as initial jobless claims also came in at hefty 420,000 claims, well above the gray line of indifference unofficially set at 400,000 claims. There are now 420,000 new savers and belt-tighteners thanks to the proliferation of pink slips. Still, we all have to eat and it is unusual to see groceries taking a hit in sales.

Personally, I think it's important to take these figures with a grain of salt. At best, the figures represent a best guess that the Bureau of Labor and Statistics puts forth. At worst, and by their own admission, sometimes they just make them up if they don't know, which goes a long way toward explaining why it's so easy to revise the January retail numbers from the original LOSS of 0.9% to a revised GAIN of 0.3%. Still, it makes me wonder how these current or revised lackluster numbers could be greeted with such enthusiasm today.

But back to gold. . .what does F.G. make of today's selloff? In two words, "Buying Opportunity". Maybe not exactly today or tomorrow for the traders among us. But if we are in the gold ownership business as an insurance policy, aka long-term hold, it looks pretty attractive here. Remember, gold is in a bull market until proven otherwise. And even despite a steep drop today, the charts tell a coming bullish story. Take a look.

Gold - April Contract chart - GC03J (weekly/daily):

First off, "coming bullish" does not equal "buy it now" if we try to time the purchase in any way, shape or form. While I personally think the price is right, I also think timing is a little early for a trade. Those wanting an insurance policy though may consider it anytime.

But here is what the charts are saying. Starting with weekly candle support at roughly $330-$332, note that dovetails nicely with support of the 200-dma - also $330 - on the daily chart. I would consider $330 significant support based on those two indicators.

But the reason I would not, as a trader, be tempted in to buy it here is two-fold.

First, the stochastics on both the weekly and daily charts are still falling - in both the 5 and 10 period lookbacks - and there hasn't been a reversal yet. Oversold, yes, but still room to fall.

Second, there is a large disparity that is just now beginning to close with relation to the 200-dma and the 50-dma. This will likely take some time. As this gap begins to close, I believe the entry opportunity becomes better. Hovering around the 200-dma for a week or more until that gap closes seems appropriate, but again the market can do anything. So make your buying decision carefully.

Remember that the 200-dma at $330, while not perfect, should provide heavy price gravity on a technical basis to that level.

Let me add one more fundamental thing here before signing off. Does everyone recall the Fed Governor, Bernanke speech, where he revealed the Fed's intent to use it's secret weapon - the printing press, capable of creating Dollars out of thin air - in order to prevent deflation from getting a grip on the economy? Today's economic reports on retail sales and joblessness should put another two sturdy nails into the coffin of the U.S. consumer. I look to those as evidence that deflation is taking hold. As the Fed attempts to print its way back to prosperity - with likely limited results - and Dollars become worth substantially less, gold will eventually shine.

Conclusion: The fundamental case for gold still stands. The technical picture shows us nearing a buying opportunity for the market timer. The price drop to $334 on a rumor just made it more attractive.

One more thing. . .for those desiring to by CEF (AMEX:CEF), the closet thing to gold certificates, and the closest way to getting real metal into our IRAs, I'm waiting for CEF to deflate out some of its premium to net asset value - strictly my opinion. There are those around here, namely Mark Phillips and Jonathan Levinson, who make a good case for ignoring the premium and buying CEF anyway on the premise that it's always traded at a premium (at least it has done so for the last five years), and will likely continue to do so as long as gold is in a bull market. Personal preference here - take your pick and use your own judgment as to how you play it.

Until next time, make a great week for yourselves!


Options 101 Archives