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In This Issue:
What market is starting to heat up? Chad Butler takes a look at recent trends in Gold that make this market one to look at.

February 1, 2007
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Now is the Time for Gold

For the past couple of years, I have been writing in this newsletter that we are in a major commodity bull market. During the past year, with the pull back in energies and metals, I have had to defend that position against “analysts” who claim that the bull market is either dead or doesn’t exist - that the commodities super cycle is a myth.

During this time, I have told you, the trader, to look beyond the commodity indices such as the GSCI because they are so heavily weighted to energies. As energies have pulled back, other markets have setup and moved forward. Look for opportunity in markets that are set up to move. (That’s smart trading regardless of whether you think there is a super cycle or not.) The most obvious place we have been looking has been the grain markets – specifically corn. While there is still opportunity in corn, that is not going to be the subject of today’s discussion. Rather, the metals are starting to heat up and it is time to look at gold once again.

Gold is confirming a breakout of consolidation on the weekly chart. Looking at the weekly chart, it is difficult to make the case that gold is not in a bull market. Certainly, it has spent the eight months consolidating gains; but looking back on the chart that is to be expected. The market has made an historic run-up and nearly reached new all-time highs. While markets do not go up forever, looking at gold’s weekly chart tells me there is still upside in this market.

(continued below...)


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Chart © Copyright 2007 FutureSource, Inc.

Based on the weekly chart, we have a bullish bias. However, to determine trade possibilities, we need to look at the daily chart. The market has been rallying and the 9 day simple moving average is about to cross above the 50 day. For my trading methodology, this is bullish. Once the 9MA is above the 50MA, we want to be looking for buying opportunities. (Important note: this is different from using the moving average crossover as a market entry mechanism – I am only using the MAs to gain a bias. I use price action to determine entries.) In addition to the setup in the simple moving average, we have the MACD crossing over as well. Note that I do not use the standard compression on the MACD. I use a 9/50 compression to complement the 9/50 SMA that I use on the chart.

Of course there are many ways to trade this market. I am only suggesting a few based on my personal trading methodologies. I suggest that you consult with your broker before determining if these strategies are appropriate for your account size and risk tolerance.

FUTURES TRADES

here are two possible entries for gold futures. The first is the breakout move above the high of the day that settled below the 20 day exponential moving average (the 20EMA trade). Seeing the settlement above this area (647.30) on 1/24 tells us to be a buyer of the following open. The market actually gave us a few additional days for those that missed the entry. The second possible entry is a breakout above previous near term high of 655.80. As a trend follower, I like the breakout trade because I am concerned with entering the market when the momentum is with the trend. (If these entries are missed, momentum players can enter looking for a breakout of next resistance at 668. If you are a trader that buys on pull backs, support should come in at 655.80, 647.30, and the areas of the 9MA, 50MA, and 20EMA.)

The stop for these trades is below the lows of the current move. This support comes in at the 605 area, so a stop in the 600 area is necessary. That makes these trades only appropriate for accounts that can handle that amount of risk. The first target on both trades is last year’s high at 732. A breakout above that and we should see the market poised to attempt the 800 level. The risk:reward from this area then is about 1:3.

OPTION TRADES

Anyone who has followed my market commentaries for any period of time knows that I like trades that provide good risk reward ratios with defined risk – in other words, option spreads. I like option spreads because they can provide a trader with an opportunity to trade a market that might otherwise over leverage their account. Gold is definitely one of those markets. The swing point on the trades discussed above takes us all the way down to 600. That’s a hefty swing for the smaller account, and frankly, that is too much risk for accounts less than $25K.

Certainly, a stop could be placed at a higher price, but that would, in my opinion, be locking in a loss. The market picture doesn’t change unless we break that 600 area of support. Due to space constraints, I cannot turn this into a discussion on stop placement, so suffice to say that, for anything with an intermediate time-frame, a stop above 600 is too high.

Using a bull call spread, however, can get a smaller trader into this market close to the money and still be able to keep the risk low enough to fit their account size without the risk of prematurely exiting the trade.

APRIL 670/700 BULL CALL SPREAD

This trade is constructed by purchasing the April Gold 670 Call and selling the April Gold 700 Call. As of this writing, the entry is about $700, which is also the current theoretical value. The spread has 54 days to expiration. That is just under two months for April gold futures to make a $30 move. If we get follow-through on this breakout, that is an achievable price. If the market is at or above 700 at expiration, this spread is worth $3000. That is better than 3:1 reward vs. risk. I like this trade because of the limited risk. Risk is limited to the cost of entry. If you want to buy more time value, you could do a similar trade in the June options.

JUNE 700/800 BULL CALL SPREAD

Lastly, here is a trade that takes a “swing for the fences.” I like to call this an outhouse or penthouse trade –is either going to win it all, or lose it all. If gold heats up on this breakout like it did last spring, we could see a run for the $800/ounce level. This trade is designed to get a limited risk look at that price. And if we are wrong, the risk is capped at what we put up for the trade.

Buying the June 700 call and selling the June 800 call is currently about a $1250 entry. (If we get a pause in upward momentum, you might be able to enter this for closer to the theoretical value, currently about $1058.) If gold makes an explosive move during the 112 days to expiration and is at or above 800 at expiration, this spread is worth $10,000. As I said before, this trade is either going to be in the outhouse, or the penthouse.

Alternatively, to get the cost down on this trade, you could do a ratio spread and sell two 800 calls. However, this is not recommended for the inexperienced traders. The risk is no longer limited, and you should be familiar with how to manage the risk on a ratio spread if the market moves above the 800 level.

For more information on trading gold, RJOFutures is offering a Gold Info Pak. This is full of information and strategies that you can apply to both the options and the futures. Better yet, contact an RJOFutures Trading Strategist to discuss a strategy in the gold market that fits your goals and objectives.

The key to trading is looking for markets that are moving. Go where the opportunity is. In the commodities sector, gold is set up to rejoin the commodities bull market. These trades should give you a number approaches to participate in an up move in gold.

THE RISK OF LOSS IN TRADING FUTURES AND OPTIONS CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER TRADING FUTURES AND OPTIONS FITS WITH YOUR INVESTMENT OBJECTIVES.


About Today's Author:

Chad Butler is a Senior Market Strategist with RJOFutures, a division of R.J. O'Brien. His 16 years of market experience includes option spread trading, diversified trend following, and development of a number of index arbitrage programs. Chad’s published work appears in McGraw-Hill's Complete Guide to Single Stock Futures, Futures Magazine, and other trade publications.  He currently writes for various commodities newsletters, including RJOFutures MarketNews and has been a featured seminar speaker teaching his various trading techniques to audiences large and small.