Why You Should Not Buy This Dip in Gold and Silver (GLD, SLV)

Gold has been a stellar performer this year, which comes to no surprise considering the alarming level of uncertainty surrounding economies in all parts of the world.

The parabolic move to over $1,900 an ounce that started in July had analysts raising price targets well beyond the $2,500 mark, a price target which was once met with vigorous skepticism.

The smell of a bubble was in the air and seeing articles about Gold Bullion Vaults running out of space, I could not resist playing the short side.

If you’re a long-time reader of this blog, you would know that I recommended going long the GLD over a year ago, when the mainstream media was recommending going short.

I’m the last person to chase a parabolic move. Knowing gold, it was only a matter of time before the madness came to an end and that it would crashing back down to earth. Which it has begun doing. Take a look at the SPDR Gold Trust ETF (NYSE:GLD) chart below:

SPDR Gold Trust ETF (NYSE:GLD)

It took about two weeks for the GLD ETF to take a whopping 14% haircut poleaxe to the face. The poor retail investors that piled in above $180 after getting caught up in the hype will not be seeing their money for quite some time.

A Gold bubble can run for months with very little drawdown. But the moves to the downside are generally swift and lead to at least 3-6 months of crappy range-bound price action. It would be unwise to load up on Gold at this point in time, unless you have several billion dollars to pour into it and dont mind waiting a 6 months to get back in the green.

Shorting at this price level is also a bad idea, so wait for any dead-cat bounces (i.e. short-covering rallies) to start a new short position. The GLD could bounce back to $165-$170 in just a couple of days, which would be the perfect time to get ready for the next leg down.

If I could find any real use for Silver, other than having fancy silverware to impress my in-laws, then I would be happy to buy some, given how it’s on sale for 40% of what it was worth 4 months ago.

But alas, I will stick to playing the short side, which has been working for me since May. See the below chart of the iShares Silver Trust ETF (NYSE:SLV):

iShares Silver Trust ETF (NYSE:SLV)

Covering some shorts at Friday’s close was only to lock in profits and not because I believe the drop is over. The downside move is quite extended, so I expect a mean-reversion relief rally to bring us back up to the $34-$36 level, which would be where I load up for the next leg down.

Lastly, the US Dollar, which is moving in lock-step in the opposite direction of these two precious metals and looks like it has more room to run.

U.S. Dollar Index

The US Dollar has been rallying strongly for a few weeks and looks like it could sustain this breakout. I would not be surprised if the situation in Europe pushes the Dollar Index up to 82-85 before we see it begin correcting. Given the underwhelming announcement of QE3 (or Operation Twist), which seems to be as impressive as most Hollywood horror movie sequels, and has not reassured the markets enough to pile into risk assets.

Conclusion

I’ll be waiting for a bounce in the metals before going short again and while I am expecting a fall rally in stocks, the action in the Dollar and the stock indexes make me worry. My advice is to wait for the indexes to break out of their range, whether up or down, and follow that next leg. In the meantime, cash is king.

Stay tuned.


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