Wednesday, October 20, 2010

Why You Shouldn't Worry About A Gold Correction

Moses Kim discusses the potential correction in gold which he views as a buying opportunity. Kim reasons that since gold has been rising for about two months, a correction is a healthy and does not indicate an end to the bull market. See the following post from Expected Returns.

The outright melt up in most assets has emboldened investors to step in on the long side (finally). I’ve been saying recently that I don’t think it’s the best time to buy either stocks or gold. Objectively speaking, there is way too much bullishness in both asset classes. In fact, I’ve been trying to prepare you mentally for a correction so that you can take the right actions when the time comes. Well today may have been day 1 of a decent-sized correction.

Everyone has gotten bullish on gold; now it’s time for everyone to get bearish. I assume you will be seeing gold bubble experts reemerge from hiding and forecast $500 gold. If you have been paying attention you will have noticed that the pattern is always the same: 1) gold rallies, 2) gold bubble experts predict a 50% decline in gold, 3) gold rallies about 30%, 4) gold bubble experts go into hiding. It’s always the same comedy.

I’ve mentioned recently that gold is overbought. However, I said that I will not be selling into overbought conditions, but looking to add on weakness. For the duration of this bull market, overbought conditions have led to a retest of the 200-day moving average. The 200-day currently sits at $1189, so a correction to $1250 or so is reasonable. In no way would a correction to these levels indicate the end of this bull market. A collapse to $850-$900 and we can start talking about some serious technical damage. But until then, all corrections should be viewed as buying opportunities.

Let me give people who are worried about today’s correction some perspective. Gold has gone up non-stop for the past 2 months, so a week or two of corrective activity is nothing to panic about. In fact, it is the most healthy thing that could happen at this point. I’ve always said that there are real human agents behind market movements. Steep sell-offs in gold are a product of mindless technical trading and weak hands liquidating. Those who come last to the party are the first to leave. The long-term gold bull (aka the smart money) is looking to buy on weakness. Think about it. The smart money was buying when everyone was selling. So the smart money isn’t trying to lock in 1.2% gains here; they are looking to add to hundreds of percents in profits. As I write this, gold is down $33. Am I upset? Nope. I’m actually pretty excited that I’ll have the opportunity to add.

Think like the smart money. Give this correction some time. Be patient.

U.S. Dollar

As I’ve said before, I’m not out to win some kind of award for blind bearishness- I’m just trying to play this crisis correctly. On a fundamental basis, the dollar is a flawed currency. Arguments to the contrary just make no sense on a number of levels. But on a shorter term basis, the dollar is oversold. I’ve said that I expect a counter-trend rally in the dollar that puts pressure on most asset classes. The dollar is currently rallying substantially. Taking a quick look at the charts, a test of about 80 on the dollar index is reasonable. A rally of this magnitude could easily bring the S&P back down to about 1080-1100. I’d feel a lot more comfortable adding at these levels.

The market is always vacillating, and it is the job of the objective market participant to play the odds correctly. I am just not comfortable being too aggressive on the long side; I had a lot more conviction when the S&P was testing 1030 and gold was testing $1160. Eventually stocks and gold will go much higher, but both assets are due for a breather. Eventually I am convinced that we will see a parabolic move in gold. It’s hard to get the exact timing of parabolic moves right, which is why I always recommend building a position instead of over-trading. I’m warning you. You may pick a couple of tops here and there, but if you get too aggressive unloading your positions at perceived tops, you will eventually miss out on a monster rally. All the optimized gains you made will evaporate in the blink of an eye. Don’t make this mistake. This is a bull market for the ages. All I can say is keep a level head and follow the advice of the best investors in history: buy the dips and hold on for dear life.

This post has been republished from Moses Kim's blog, Expected Returns.

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