Friday, January 2, 2009

Time for a correction

Today was a telling sign in my mind that gold stocks and gold are due for a correction. While commodities, commodity stocks and the general stock market rallied hard to the upside, gold and gold stocks were down. They are overextended, losing momentum and ready for a correction. This is healthy and normal - markets do not move in a straight line unless they are in a blow-off top or bottom.

The gold price first:

And gold stocks, represented by the ETF with ticker GDX (the best "easy" way to play the gold stock sector and diversify away individual company risk):

After over a 100% gain in 2 months, gold stocks as a sector need a rest to solidify price gains and get ready for the next leg up. The relative outperformance of gold stocks compared to the S&P 500 over these past two months forms a ratio chart (i.e. GDX divided by the S&P 500) that looks just like the chart of gold stocks themselves:

Precisely timing trades is obviously difficult or everyone who tried it would become rich. However, one of the many things I have learned about trading is that there are times when the risk to reward ratio is against you and times it's in your favor. It's always better to trade the latter to improve your odds of success. I wouldn't advise those with a longer-term investment horizon to sell gold stocks here, but I also would advise against putting any new capital into this sector until a decent correction occurs.

When gold stocks correct, it generally takes them 1-2 months to do so if they are in the midst of a bull leg up. I would wait until early February to consider new positions in this sector, unless you want to go short as a quick trade in which case I would say today would have been a good day to place your bet.

You can see my prior real-time calls on trying to time the gold stock sector during the fall crash here, here, and here - not perfect (except the last one...) but not bad and this sector made me some good money over the past 2 months. I shall return for more bullish action in this sector in 4-8 weeks!

I added to my SRS position today, as the commercial real estate sector also showed weakness and managed a 3% loss today while the S&P went up 3%. This is a quick trade looking for a 10-15% return in a few weeks. I even opened up a small trade against the gold sector today, buying puts on blue chip gold miner Newmont (NEM) that I plan to sell within a few weeks.

Wikinvest Wire