How to Trade Gold’s Next Downturn

We certainly live in crazy times.

Following their worst yearly start in history, US stocks hit a fresh-all time high last month.

Is it a time to celebrate?

I’m not too sure.

Stocks have started to pull back, and huge uncertainty remains. The combination shouldn’t bode well for Aussie stocks, which tend to track those in the US. Looking forward, Aussie gold stocks could take a decent hit, which would offer a huge buying opportunity in the months ahead.

I’ll explain…

Global stock market update

First, let’s talk financial markets…

The US S&P 500, the broader market benchmark, rose last week to close at 2,173.60 points. That’s just shy of the last all-time closing high of 2,175.03 points. The benchmark index closed down 0.1% for the week, but gained 3.6% for the month.

The Dow Jones Industrial Average Index, the institutional money index, fell last week to 18,432.24 points. The blue-chip index posted a weekly loss of 0.8%, but ended the month up 2.8%. In an updated special report to Resource Speculator readers last week, I wrote:

I believe that we’re looking at a 20–30% stock market correction from the [recent] high on the Dow Jones Industrial index. That means the Dow could drop down to about 13,000 points. As you know, the Aussie market tends to follow in the US markets’ footsteps. But, unlike US markets, the ASX has more exposure to mining stocks. For this reason, the ASX 200 could fall to 4000 points.

If you want to read the special report in full, see the details below. In my view, you should be able to buy the best resource stocks for bargain prices in the months ahead. That’s great news if you want to make huge profits in the medium to long term. For now, however, our market is holding up well.

The ASX 200 climbed 1.2% last week to close at 5,562.3 points. After announcing a US$352.4 million profit for the year, sleep disorder treatment company ResMed [ASX:RMD] jumped by 6.9%. With plenty of good news last month, the ASX 200 surged a staggering 6.3% higher. July was the best recorded month since October 2011.

But, as we know, nothing lasts forever. The good times can change very quickly.

The Reserve Bank of Australia meets this week, and is likely to lower interest rates. The market prices in a 66.5% chance of a rate cut. Meanwhile, the earnings season kicks off on Tuesday. According to CommSec,

The earnings season generally peaks in week three, which is when the largest number of companies issue their profit results. August can be a volatile month for markets should earnings surprise.’

Based on my analysis, you should take some profits off the table. The higher Aussie dollar probably won’t bring good news for profits. That could kick start a 20–30% correction in the weeks ahead.

Looking at crude stocks, the oil price is starting to plummet, as I warned you numerous times near the top. If the ASX 200 starts falling with crude, a knife could be put to the best energy stocks. Plus, if the US dollar continues its explosive run, which I expect, commodity prices — and mining stocks — are unlikely to fare well in the months ahead.

Having strengthened my top-down investment approach, I plan to recommend the best resource stocks for Resource Speculator readers when commodities start pulling back. So make sure you have some cash free. Remember, the most successful investors buy low and sell high.

On that note, let’s turn to gold

Expect the unexpected

From a medium to long term perspective, gold stocks remain possibly the best investment. There are plenty of reasons to own them — terrorism, an emerging world war, negative interest rates, looming electronic currencies, terrible fiscal management, and an imminent banking and sovereign debt crisis. I could go on…

Greg Canavan, Editor of Crisis and Opportunity, agrees with my medium to long-term view on gold. Having backed the best gold stocks on the ASX, Greg’s made some tidy gains for readers who followed his recommendations.

In the short term, however, Greg — like myself — isn’t convinced that gold is ready to take off.

In his new free report, Greg warns readers about a potential gold correction. Based on his bullish long term outlook, Greg recommends taking advantage of the correction and buying the best gold stocks on the dip. You can read about his recommendations here.

Of course, as the saying goes, there are million ways to make a million bucks. My short term strategy involves sitting on the sideline until:

  • Gold crashes to US$931 or below or,
  • Gold proves itself and breaks out into a fresh bull market.

Unfortunately, despite surging to a new high last month, gold failed to impress. Having exceeded the number on an intra-month basis, gold closed below the US$1,360 per ounce major resistance level. I discussed this target multiple times in Money Morning last month. You can see it on the monthly chart below, with the main resistance shown in blue.


Source: Resource Speculator; Money Morning
Click to enlarge

Because gold didn’t formally break through US$1,360, and the major blue resistance line held, there’s still the risk that it could collapse to US$931 per ounce. That’s shown by the green line. The pink line shows the majority of support dating back to 2011. That needs to break, for my forecast to come about.

I’ve argued multiple fundamental reasons why gold should fall in the months ahead. Another reason is the commitment of traders report (COT). The most recent COT report (dated 26 July) is shown below.


Source: goldseek.com
Click to enlarge

The COT report shows how many traders are long or short the market. In other words, it tells you how many punters believe that gold will move into a bull (long) or bear (short) market. At this particular time, there are more large speculators who are buying gold — and more institutions who are selling gold. The gold shorts are at a near record high.

It’s a major warning…

Based on my experience — no matter how bullish the market is — when the commercials COT report is negative, gold tends to fall. In 2011, when gold was trading at its peak of US$1,920 per ounce, it looked like gold was going to scream higher. But the next thing you knew, gold fell off a cliff quick and hard. A big reason for that was the COT report.

When you least expect it, the commercial short contracts could kick in, and gold could be trading US$300–400 per ounce lower. For this to happen, the US Fed probably needs to signal that it will raise rates in the months ahead. You can take that however you want. But, it’s another BIG reason why I’m not recommending Resource Speculator readers to buy gold stocks, YET.

Talking strategy

Looking forward, at the very least, you should have a strategy and stick with it. Sure, traders can make a lot of money shorting gold — and gold stocks — and then buying them back near the low. Traders can also make a lot of money buying the best gold stocks during the dips and holding them for medium to long term.

In Greg Canavan’s view, the coming correction won’t be as big as I think. He believes the bull market has already started. For this reason, you should buy the best stocks when they fall. If gold falls by more than Greg expects, don’t worry. Greg’s implemented a stop loss strategy to protect your capital and gains. Plus, if you don’t want to sell them, you should still make a lot of money on them in the medium to long term. It’s a solid strategy. To read more about it, click here.

As for my approach, if gold collapses to US$931 per ounce — or lower — I believe that Resource Speculator readers will make life-changing gains buying the best gold stocks near the low and holding them for the medium to long term. While we wait, I’ve found three stocks that could make you huge profits in the months ahead. To find out more, read your free report here.

Regards,

Jason Stevenson,
Resources Analyst, Money Morning

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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