Breather or Bear Market? Gold Bulls Stumble in Trading Yesterday

By Mike Caggeso
Associate Editor

Nearly every U.S. consumer is feeling the continuous slow burn from this summer's credit rout. If it didn't devalue their home or stocks, it trickled into the higher costs at grocery stores and gas stations in the form of rising commodity prices and a weakening dollar.

These credit-induced pains can be traced to mid-August, when the credit woes caused the Dow Jones Industrial Average Index to temporarily turn tail and head south. Even though the Dow rebounded, there's been a heightened volatility in the markets ever since.

If the trading action yesterday (Monday) is any indication, the next investor darling to enter "The Volatility Zone" could be gold.

Gold Soars, then Suddenly Reverses Course

Since August, the yellow metal has had a historic run from $650 an ounce to its trading high of $844 last week, visiting territory not seen in nearly 28 years. [The all-time record high for New York Mercantile Exchange gold was $875 set on Jan. 21, 1980, and the record settlement price was $825.50 set on the same date]. Even with a modest decline Friday, when it closed at $834.70, gold advanced $26 an ounce last week, achieving a closing high of $837.50 on Thursday.

The bottom line: The price of gold had rocketed nearly 30% in three months.

In early trading yesterday (Monday), however, gold for December delivery dropped $26.50 an ounce, or about 3.2%, bringing the price down to $808.20 on the Nymex. Gold actually closed at $802.90 an ounce yesterday.

But analysts are split as to whether this is actually the start of a price reversal - brought on because of the speculative excesses that have dominated the gold market of late - or a temporary respite from a prolonged bull market in gold.

Either way, you can profit.

The Fuel Behind Gold's Bull Market Run

The reasons for this run-up in the price of gold are similar to those cited above - the declining greenback, volatility in the worldwide financial markets driving investors to such "safe-haven" assets as gold, and soaring run-ups in the prices of other commodities.

Gold has always been seen a hedge, but "gold bugs" have also traditionally viewed it as a profitable investment, too. With soaring demand fueled by China and other emerging markets, many experts are forecasting a long-term bull market in gold prices.

[To read a related Money Morning news story from late last week, "UBS Boosts Target Price for Gold Stock Recommended by Money Morning," please click here. This news story also has links to a free research report on profit opportunities in global gold shares].

Add U.S. Federal Chairman Ben S. Bernanke's second reduction of the benchmark Federal Funds Rate in two months into the mix, and one can make an even stronger case for gold to continue its record ascent. In fact, analysts around the world seem comfortable saying gold will hit $1,000 an ounce. And that's not an outlandish prediction.

After all, the rise from $260 back in 2000 to $825 today has been reasonably orderly, even with the frenetic increases of late.

But let's adopt a bit of a Contrarian stance, here. With the recent price action in gold, it's no surprise the yellow metal — often a haven for bears — is quickly attracting profit-seeking bulls. But if gold prices continue to advance at the more energetic pace of late, will this bull market turn into more of a speculative bubble?

Or, even if the long-term direction is up, will there be a near-term correction that will let investors get aboard at lower prices?

These are both excellent questions to ask, so let's look at both a bit more closely ...

Four Reasons Why Gold Could Dip

  • First, when cutting the U.S. benchmark interest rate a quarter point to 4.5%, Team Bernanke strongly suggested it wouldn't reduce rates again anytime soon. The inference there is that the money spigot won't be opened up wider, meaning the greenback's rate of decline could slow, or perhaps even reverse. Gold prices generally move opposite the dollar. And now that many forecasters say that Federal Reserve policymakers won't reduce rates again (thereby keeping the dollar from sinking lower with another rate cut), gold could tread water, or perhaps even backpedal.
  • Second, the value of gold, like the value of other commodities, is determined by how much people are willing to pay for it. For example, gold miner AngloGold Ashanti Ltd. (AU) has recently "sold forward" three years of its gold mine output for a set price of $600 an ounce. This is important. One of the world's largest and most-influential gold companies is selling gold's future short - in the face of skyrocketing prices. Compare its actions to the trading of a corporate insider. Companies announce buyback programs because they believe their stock is cheap now and will be worth more in the future. They also sell shares when they know that their company is in for a rough ride. And company insiders know better than anybody else when and why to sell or buy their own stock.
  • Third, gold is trading at a 28-year high. And the gain of nearly 30% of the past three months could persuade many investors to cash out, opening up supplies. Such could be the case for gold's nice, round number of $800 an ounce.
  • Fourth, UBS AG (UBS) believes gold may be overbought because sales of gold-oriented exchange-traded funds (ETFs) are slowing and high prices have lowered demand from India [very much a gold-hungry market], the Financial Post reported.

How to Profit from Gold's Dip

Back in 1980, gold soared briefly to $850 per ounce; that's equal to $2,000 per ounce in today's money [and represents an eventual - long-term - target price for gold, according to many experts]. So even if the price of gold matches that $850-an-ounce record high, it's actual value won't even be close - at least when you adjust for inflation. That means there is a lot of room to grow.

A temporary price blip, if there is one, won't shake loyal gold bugs free. But when newfound gold bulls see the yellow metal's price run-up slow, they'll throttle back on their purchases - perhaps even bringing about a near-term price reversal.

Ultimately, however, gold will resume its inexorable run for high ground. So watch for a reversal, and view it as a chance to buy in at bargain prices.

[In case you missed it, Money Morning published a two-part series on gold investing recently, and detailed five global gold plays to make now. The first part ran down a litany of reasons why to get into gold. The second listed and reviewed each of the world's 12 major gold mining companies, and presented five global profit plays in gold. To read Part II of that report, please click here. It is free of charge].

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