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In the last 12 months, our biggest and most profitable trades have been in gold stocks and XAU options (see client emails). We see no reason for that to change. Between now and the end of the year, we strongly believe--assuming gold stocks remain in a long-term bull market--that the XAU will continue to provide the most rewarding trading opportunities. Here are our reasons why:
Gold has been in a long-term up-trend for four years, and unless it closes below $400.00 for two consecutive weeks, there is no technical evidence to base upon any bearish view on gold, other than speculation based on intellectual arguments. For all means and purposes, as long as the trend remains positive, we will remain long-term bullish on gold, although short-term we are bearish. The gold/xau ratio has been a rather accurate indicator for intermediate term signals. Notice that the average "cycle" duration from entry point to entry point since the beginning of the bull market has been roughly one year. We believe that over the next few weeks we will see the beginning of another such cycle.
In our analysis posted on 3-8-05, we opined that the XAU was in a declining channel, and that it would turn down violently once it reached channel resistance. We predicted that the XAU would collapse down to the 90-85 area in a matter of a few days. Last week in a stunning 4-day decline the XAU lost 10% of its value, vindicating our forecast, and giving us reason to believe that since so far our forecast has been correct, the odds are better than even that the rest of the forecast may also turn out to be correct.
The XAU gapped down and went straight thru its 20 dma, its 50 dma, and all three fib retracement levels (see different color lines) without the slightest hesitation. Based on our measurements of the magnitude of the downside momentum thrust and on the chart pattern, we believe that going forward the two most probable scenarios are the following; a) the decline will continue un-interrupted all the way down to longer term channel support around 85-84, or b) we get a bounce between 89.9 and 90.90 up to 93.75-94.75, and then another leg down to 85-84. If gold and gold stocks remain in a bull market, the decline down to 89-84 zone ought to represent the last buying opportunity for gold and gold stocks prior to a spectacular bullish acceleration. If the XAU stays above 84 over the next 2-4 weeks and then it begins to accelerate to the upside, at this point in the bull market we ought to see a rise from its upcoming lows in the 89-85 zone in the next few weeks to a high in the 155-165 zone by the end of the year, which will represent an 100% gain.
If the XAU remains in a bull market, it ought not to violate support at 84 on a weekly basis. We would allow for an intra-day move to as low as 81. However, two consecutive weekly closes below 84, or even worse below 81, accompanied by gold closing below $400 for two consecutive weeks, would call the bull market assumption into serious question. If that were to happen, at the very minimum we would change our long-term view from bullish to neutral. Trading strategy: Currently we are holding XAU puts because we expect the current decline to continue down to the 90.9-89.9 zone, and perhaps down to 85-84. If support holds between 89.9 and 90.9, we will close the puts and initiate a small call position (20-40 contracts) which we will close if the XAU rallies up to 94.75 and it reverses to the downside. At that point we will open a 60-100 contract position in puts, which we expect to close in the 85-84 zone. Assuming the 85-84 zone holds and the XAU reverses to the upside, we will start buying our favorite gold stocks, coupled with XAU call options. If the 85-84 support zone doesn't hold, we'll close the puts and do nothing until we have enough data points to re-evaluate. Ike Iossif
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