Where We Are in this Parabolic Gold Rally?

By: Boris Sobolev, Resource Stock Guide

November 29, 2009

The following are excerpts from RSG Newsletter dated November 29, 2009. To subscribe, please follow this link.

Another Debt Cloud Rises; It Won’t Be the Last

$60 billion worth of Dubai state company debt threatened by default hung over the market last week. To understand more about Dubai and who runs it, click on this link to a BBC article.

Fears that the events on the Arabian Peninsula could lead to a second wave of the financial crisis caused a serious sell-off in Asia last week.

However, the influence of the Dubai event on the US market is still difficult to assess due to light trading on Friday. As far as the consequences of the coming default or potential restructuring of the Dubai debt on the world financial system, we agree with Cumberland Advisors’ point of view.

“The panic associated with the financial difficulties of Dubai’s government-controlled Dubai World is having ripple effects into commodities, developing countries, and other markets. Such contagion seems to have become commonplace now, as the short-run interests of traders in worldwide markets are matched against the interests of long-run investors.”

“Will the spillover effects require action in the U.S. by the Federal Reserve? The answer is, not likely. US financial institutions are not exposed to Dubai to the significant extent that European institutions are. Furthermore, discount-window and other borrowing facilities are already in place, should liquidity be needed. Since the dollar is benefiting temporarily from this crisis, reversing its recent declines, there is no likelihood of or need for a currency intervention by US authorities”.

However, for the US stock market which has not experienced a sharp correction since early spring of this year, short term reaction could still be substantial. Critical level of support for the S&P 500 is now 1050-1025. If this band of support is broken, a significant correction could unfold.

Short Term Targets Reached; Sharp Correction Looming

In connection with another massive bailout on the horizon, gold fundamentals continue to improve.

In our October 24th newsletter, we pointed at a super-bullish short term target for gold of $1150-$1200. Last week, the target for this scenario was reached. As a result of the parabolic upside we have seen in the past four weeks, gold has now approached extremely overbought levels.

Weekly Gold Price

At the same time, sentiment readings on the metal have also reached levels from where corrections had begun in the past.

Courtesy of sentimentrader.com – excellent source for sentiment data

Our November 15 flash alert stated the following:

“After gaining 2.2% last week, gold is now again somewhat overbought. It is entirely likely that a correction could be close. However, we do not yet see any clear signs of a gold market top. Bullish action could continue further”.

“Since we have substantially increased our positions in PM Stocks two weeks ago and, as a result, have done well, we are now looking to start taking profits”.

“If gold reaches $1140 in the next few days, we will begin to cut our trading positions at an even faster rate. We are certainly not bearish but instead, are trying to be prudent. We simply would be more comfortable with a larger cash position when the next correction begins. Since a parabolic move in gold remains a possibility, we do not plan to sell any of our core positions”.

As planned, we have reduced our trading positions to almost zero and are comfortable with waiting for a new entry point. First significant support for gold is around $1140. If this support holds, a parabolic upside movement in gold into the upper 1200s could continue.

Hourly Gold Price

However, we believe that it is more likely that as the next move, gold will test $1100-$1070.

We anticipate to again become aggressive buyers at those levels if we do not see major changes in the behavior of the financial markets. Keep in mind that a 10% correction in gold could lead to a 20%-30% downside in precious metals stocks. As a result, we could see $XAU test its 200-day Exponential Moving Average next month (currently at 153 on the chart below).

At this time, we prefer to exercise caution, focus on capital preservation and wait for gold stock prices to come down.