Gold Meets The Fonz

Sat, Nov 13, 2010 | Jared Woodard

Market Commentary

Yesterday’s “5 Dumbest Things on Wall Street” column on TheStreet.com supports my prior comments about a likely bubble in gold. The version picked up on Yahoo Finance introduces Number 3 with the subhead “Gold Jumps the Shark”. Intercontinental Exchange (ICE) is accepting gold bullion as collateral for positions in energy (yes, this is actually true):

This week, London-based Intercontinental Exchange (ICE) announced that it would begin accepting gold bullion as collateral for energy and credit trades. Take a step back and think about that for a minute: traders will use a highly volatile commodity to back trades—or increase margin—on other highly volatile commodities and derivatives.

So, let’s just take a peek at a chart of gold overlaid with the prices of light crude and the US Dollar Index (click to enlarge):

Two things jump out, which, it seems, the geniuses at ICE can’t see (their heads apparently being up their…backsides). With the exception of the bubblicious parabolic climax in gold since last spring, oil and gold are highly correlated in direction. The dollar, on the other hand, exhibits an inverse correlation, which makes much more sense for an asset used as collateral.

Gold is hugely overbought in the weekly and monthly timeframes; the concept of “hard currency” is long dead; and the obvious decoupling of gold and oil adds to the evidence that gold is in a speculative bubble. No doubt, some readers will criticize this analysis as beating a drum long enough that I’ll eventually be right, like a broken clock (apologies for the mixed metaphor). My response is that this is exactly the kind of nonsense contrarian investors use to identify a buying climax. It would be wise to be cautious about buying gold right now, and anyone who’s sitting on a big paper profit might want to lock in a portion of that gain.

And, finally, it might be smarter for ICE just to accept the good old US dollar (well, not quite as good as it used to be), and stay away from gold as margin for energy positions.

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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