As it became clear that we were consolidating and not shooting higher, I began to wonder what was in play. Interestingly, two of the technical guys I talk to said essentially the same thing.
Take a look at the above chart. It is a yearly of GLD (not Comex gold, but the chart is essentially the same). Notice all of the consolidation at the end of the chart. That has been the sideways movement gold has seen since my last writing. Consolidation like this is likely to become significant support or resistance going forward (depending on which was we move from here).
But pay attention to the formation of the chart starting in March through where that consolidation begins. You see the formation of a rounding bottom, or U, or as some would say, the cup part of a cup and handle formation (the handle being the recent consolidation). A break above this level would signal a continuation above the uptrend. But how do we know if we have stalled to the point that this upward trend becomes negated?
Those who follow Fibonnaci retracement theory will point out the key ratios of 38.2% and 61.8% as key technical levels of a retracement. So what does that mean?
The highs in March that you see on the above chart (if the chart doesn't show up just go to any major site and look for a 1 year chart on GLD) correspond to approximately 1780/oz in Comex gold. The all-time high in gold was made last September (not on this chart) at about 1920. So here are the key numbers; 1920, 1780, 1530. From 1920 to 1530 (the lows just below 150 that you can see on the chart above) is approximately 400 bucks. 61.8% of 400 is about 250. So a 61.8% retracement of the move from the highs to the lows would be about 250 dollars. 1530 (the low) + 250 gets you 1780, right where we stand and consolidate now.
The inverse of 61.8% (38.2%) should be considered when deciding if and when this up-move has stopped. So since this move off the bottom is about 250 bucks (1530-1780), a down move from the top of 38.2% should stand to negate the move. 38% of 250 is just under 100 dollars. That means that presumably gold could come off down just below 1700, and the long term up-move we are seeing would not be negated. As such, the small short term down moves are not of great concern to the gold bulls. We are a 70$+ move to the downside from even having to consider the long-term bearish implications of this slow down.
The important takeaway from this is that the range of the cup (formed by 1780 in March, down to 1530 and back up to 1780 again) should represent our upside target from the point of consolidation. In English; We retraced 250 dollars up to 1780. It we break above this level to the upside, we should expect to go about 250 dollars higher, giving us a target over 2000/oz.
What are the options telling us?
The truth
For weeks options have been getting cheaper and cheaper; and the wing options (lower premium options that people buy in expectation of big moves) have also been getting cheaper. At the money front month options are trading below 14% volatility. In simple terms, 16% volatility implies that gold would have a daily range (high to low) of about 1%, or approximately 18 bucks. We are seeing much tighter ranges, and thus the options pricing has been appropriate. While relative to recent memory these options look "cheap" they are telling of just how muted futures movement is.
Since options have been a pretty good indicator of the futures market of late, I would like to point their seemingly directional bias. In a vacuum, movement is what dictates options pricing. If we see a big move in either direction, options should get bid. However, we see times where this not the case. For instance, a few months back when gold rallied over 50 dollars on an employment report miss (biggest daily up move in years), volatility got offered (options got cheaper). There are no precise explanations for how these things behave, but keep in mind that options pricing is forward looking. A big move today does not imply a big move tomorrow. If for instance we have a big move that puts gold somewhere on the chart where we historically haven't seen movement, we might see options get cheap. The big move is good for people who are long options (long gamma more specifically), but it will not necessarily entice new options buyers to come to the market. Lately, on intra-day down moves, we have not seen options get bid. This indicates to me that market participants do not believe that a temporary down move implies continued moves to the downside (or rapid snap-backs to the upside). Gold options have tended to get more bid as we move up, which could be considered bullish as options traders are betting that significant movement is more likely to occur as we move higher. All that being said, with QE behind us, short term catalysts for dramatic moves are rather few. For now, the sideways story continues.
Have a great fall football weekend,
Ben
