Is Gold Going Parabolic?

10/15/10 08:43:54 AM

by Donald W. Pendergast, Jr.

With gold on track to demolish a key resistance level this week, traders and investors have to wonder: How high will gold go?

Security: GC, GLD, IAU
Position: N/A

A trend in motion is a wonder to behold, especially if you're enjoying the gains to be made by being on the right side of such major market moves. Picking tops and bottoms becomes a fun game to play, and not something any sane trader would actually attempt to do with real money on the line. Not that it isn't being done by traders -- it is -- but it's still a low-probability, high-risk venture, especially when trading futures contracts. Here's a brief look at the weekly trend in the gold market, a market that appears to be accelerating in parabolic fashion, and one that top pickers should take a pass on -- for now.

FIGURE 1: GOLD. With gold starting what may be a new parabolic thrust higher, the Keltner complex may help provide gold futures call option sellers with a general target zone for a possible reversal. Weekly gold futures have only closed above the top Keltner channel three times since 2000; they did so for three consecutive weeks in spring 2006, just before gold plunged by 23% in just five weeks.

Graphic provided by: TradeStation.

On Figure 1, a weekly chart of continuous gold futures, I've overlaid two Keltner bands; the inner channels are set at 4.2 average true ranges (ATRs) away from a 45-week exponential moving average (EMA) and the outer channels are set at 7.5 ATRs away from the same 45-week EMA. On only one occasion during the past 10 years has this weekly gold chart managed a weekly close above the extreme Keltner channel, back in May 2006. Back then, gold futures made three consecutive weekly closes outside the upper band before plunging nearly 23% in the following five weeks. Gold came very close to the extreme upper channel in March 2008 (within $14) and once again proceeded to sell off hard, shedding more than 34% in seven months. December 2009's high in gold made it about halfway between the two upper channels, then reversed course, dropping by about 15% in two months.

So what are we looking for now, anyway? Since we already know that the tippy-top Keltner band is one tough nut to crack (remember, as a volatility-based indicator, Keltner bands automatically take into account the increased or decreased range of the price swings when calculating their new price level, making them especially useful for those seeking a reliable leading indicator), we already have an idea of where gold may meet up with statistically significant resistance.

This makes the channels very valuable to futures option sellers who like to sell greatly inflated calls and puts at strike prices far beyond the levels of the extreme outer Keltner channels. For example, say gold really does ramp up hard for the next four weeks, finally making an interim high near $1,525. If that occurs, call option premiums for February 2011 or April 2011 COMEX gold futures are going to be selling for a mint, even on far out-of-the-money strikes at $2,000, $2,500, and even as far out as $3,000. Knowing that gold is more likely than not to take a rest after rising so quickly into such reliable resistance areas will embolden savvy option traders to progressively scale in to their call sales; maybe they'll sell one April $2,200 call with gold at $1,450 on the way up, then an April $2,400 call with gold at $1,525. Even if the bull run continues to $1,600, you'd still have a very nice safety barrier between the current price of this raging bull and your short call strike prices. Wise option sellers will want the deltas on their short calls to be less than 20, if at all possible.

Meanwhile, with all of that said, please note the twin Fibonacci extension resistance levels on the chart (midway between the two upper channels); these are based off of two of the more meaningful A-B (X-Y) price swings of the last few years and they both plot a Fibonacci 200% expansion level of resistance between $1,425 and $1,444. This is yet another place to start writing up your gold short call shopping list and might even provide a good base from which to progressively scale into your short call positions. This strategy is not recommended for:

A. Novice futures traders
B. Traders with no futures options experience
C. Futures trading accounts with less than $50,000 in cash on hand.

The more money you have, the easier it is to scale into positions and eventually turn a nice profit (now you know why Goldman Sachs and JP Morgan hardly ever lose money on trades like these -- the dudes with the deep pockets have the staying power required to wait out nearly any market move), but even if you have a modest account ($15,000 to $25,000), you might still be able to sell a couple of far out-of-the-money gold calls without causing too much emotional mayhem for yourself. Just remember to respect the power of a trend in motion and to use your head in case things get out of hand. If any of your short gold calls double in price, buy them back ASAP and call it a day. There will be other option selling opportunities ahead, of that there is no question, so watch and wait for your perfect setup to come along -- and then go for it.

Incidentally, both the gold and silver (and copper, too) futures markets have very negative seasonal chart patterns for October, so be watching for any of the previously mentioned resistance areas to give these metals yet another reason to begin another round of corrections. The next two to four weeks in the gold and silver market should be very memorable. Very memorable indeed.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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Is Gold Going Parabolic?

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