Technical Trading Ideas: GLD

by on November 5, 2010 | ETFs Mentioned:

The markets have managed once again to take investors on a wild ride this week, with the S&P 500 breaking and closing above the psychologically important 1,200 level. The rally on Thursday was an overwhelmingly positive reaction to the Fed’s decision to pump more money into the market, sending both equities and commodities sharply higher. Friday’s positive unemployment report represented another round of good news, giving investors hope that job creation is beginning to accelerate [see Wild Thursday For Commodity ETFs].

Gold has been no stranger to the headlines in 2010, as the precious metal has surged higher thanks to lingering anxiety over the global economic environment, concerns about long-term inflation, and consistent weakness in the U.S. dollar. The yellow metal has repeatedly touched new highs throughout the year, generating handsome returns for several large hedge fund managers who have established huge positions in bullion [see Three Legendary Investors Bet Big On GLD]. And some think that the gold rally still has  more room to run; Goldman Sachs recently set its 12-month price target at $1,650 an ounce, an increase of more than 20% from recent closing prices. The bank cites this week’s price action and U.S. monetary policy developments–which could spur eventual inflation–as significant factors in driving the price of gold higher.

As interest in gold has surged, so too have assets in physically-backed ETFs, a popular tool for all types of investors to establish exposure to precious metals. The SPDR Gold Trust (GLD) is the second largest U.S.-listed ETF by total assets, currently standing at about $57 billion. GLD, which stores gold bullion in secure vaults, has climbed to all-time highs this week, managing to close above its previous high of $134.85 set on October 14th. GLD has been in an uptrend since its appearance on the exchange in 2005, as gold prices have steadily climbed higher. The last significant correction that GLD experienced was in the second half of 2008, when it retraced from slightly above $100 to $66 per share [see The Definitive Gold ETF Guide].

Technical Insights

One popular technical analysis approach to trading GLD is to draw a reverse Fibonacci Retracement from the peak to the low point of its last correction (mentioned above). This process reveals key price levels that many technical traders will consider when evaluating GLD’s recent rally. Looking back, we can see that GLD struggled with the 161.8% level–a key threshold in reverse Fibonacci retracements–before managing to break through last month. With this level in the rear view mirror, the next significant price level when looking at Fibonacci Retracements is 261.8%, which corresponds to a per share price of about $156 for GLD. Given current economic conditions of low interest rates and a falling dollar, the technical prediction for GLD seems reasonable (it is, in fact, well below Goldman’s more bullish prediction).

Trade Ideas

When trading gold (or physically-backed gold ETFs), it is extremely important to exercise caution since bullion prices are subject to price volatility and shifts in investor psychology–making it difficult to gauge appropriate entry points. Also, it is critical to note that the Stochastic Momentum Index is signaling that GLD is overbought from a monthly time perspective, as well as from a weekly and daily view. If GLD is to chase its next price target of $156.16, it first needs a reasonable retracement so it can build support as it prepares to make the next move higher [see Gold ETFs: Boom Or Bust?].

Once again, we can use the Fibonacci Retracement tool to identify significant price levels that GLD is likely to retrace to, considering that it is overbought from multiple time perspectives. If we draw the retracement from the start of its last uptrend to its current peak, the first price level suggested for GLD is $134.74, and the next comes at $133.60:

A conservative suggestion for trading GLD is to watch its 1-hour Stochastic Momentum Index as it retraces, and take note of whether GLD is building new support at a higher price level. If the view on gold is aggressively bullish, one strategy is to add to GLD positions as the fund dips by keeping an eye on the 15-min Stochastic Momentum Index. It’s not impossible for GLD to continue to climb higher aggressively, as its Daily Stochastic Momentum Index was overbought from the end of September through the beginning of October.

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Disclosure: No positions at time of writing.