No matter your approach in trying to make sense of the politics at work in the USA and Europe concerning debt, it becomes almost a pointless exercise since the political game landscape changes too fast to get a handle on the impact to gold prices.

Let’s start with Europe. This week Greece’s Bonds were downgraded again. They are now basically junk. More important, why would anyone buy them “knowing” that haircuts on them is likely or unless they could be bought at a deep discount that takes in account the worst case scenario in the pricing of them.

The European Central Bank, the same bank which over the past months has been adamant about not taking bonds that were part of a Greek restructuring program, seems to be changing or has changed its stance. The ECB president is now in the process of doing an about face and has been quoted as saying those bonds, the ones he wasn’t going to take as collateral, will be acceptable as collateral because of the guarantees behind them. Is it politics or reality that has changed the bank’s leader’s opinion? Probably reality that without taking them the system would be a lot closer to collapse.

In the USA the most pressing issue is raising the US Debt Ceiling. How it gets done is the question. Compromise, Presidential decree, one party winning enough votes with some crossover voting or whatever. In the end, I believe that the debt ceiling will be raised. It’s now taken on the aura of becoming a game of tag, getting tagged with a negative “tainting” from the fallout of doing nothing and the consequence of doing nothing that each political party must avoid going into next year’s elections. I can’t get away from thinking that politicians look way more stubborn than usual. It’s abundantly clear to me that what we’re really witnessing is the run for the next Presidential election. President Obama does not want another debt ceiling vote right in front of his next run for the Presidency. The Republicans want exactly that.

What about the threat of a US default? Will the US default? I seriously doubt it. The August 2^nd date is most likely a fictitious “line in the sand” date that has a buffer of time behind it.

More important I don’t see the US defaulting because the consequences of one are simply too great. Unlike Greece we can pay our bills. What the budget fight in large part is about is making sure we don’t end up like Greece, given we are spending much too much in terms of the US’s income.

Later today the House of Representative will vote on the Boehner bill. So what! If it passes the question will be how can it make it through the Senate and a threatened Presidential Veto. One way would be to use it as a compromise. If not, the vote in the House is simply grandstanding.

As for the credit rating agencies, S&P and Moody’s have alluded to or said that unless the US cuts 4 trillion Dollars and gets some credible mechanism in place to reduce spending, that a credit downgrade by them is on the horizon. I think this is going to be the outcome unless magically, Congress gets back to reality and reaches a meaningful bipartisan agreement.

I also think that there will be a last minute raise in the debt ceiling.

Therefore I am in the camp that thinks the likelihood of a credit downgrade is likely but not in the camp that thinks a credit default will take place. Ultimately some budget is going to pass. What type remains to be seen.

According to a report issued by USAGOLD (www.usagold.com), from the end of July to the end of December the following gains and losses have been recorded since 2001.

·         2001  + 2.8%

·         2002  + 7.9%

·         2003  + 18.0%

·         2004  + 10.1%

·         2005  + 20.0%

·         2006  + 2.8%

·         2007  + 26.2%

·         2008  -  5.0%

·         2009  + 15.7%

·         2010  + 15.9%

If you average all the years together, you arrive at a past average percentage rate of return of 11.4%. From this point you can do a lot of modifications to either raise or lower your year-end expectation. For example, you can manipulate the numbers by throwing out the highest returns, you can give more weight to loss years and so on. It really doesn’t matter other than keeping in mind that there was a loss of approximately 5% in 2008, so the possibility of prices not gaining is there.

The above chart provided by The Moore Research Center offers a historical perspective forward from this point of the year in terms of both Bull and Bear Market years. Given that a new all-time high was just seen in gold, I rate 2011 as a Bull Market Year. Therefore, until something occurs to deter this, I believe that this chart provides another piece of the puzzle you can use in trying to figure out if prices are going to be higher or lower by year end. My guess is higher.

Below is a Daily Chart of the August Gold contract.

Each individual “green” bar on the chart represents one day’s trading session. In “red” I have plotted the 18-Day Moving Average of Closing Prices and in “brown” is the Swingline Study.  

The Slow Stochastic Study is displayed on the bottom graph between dashed lines between a ratio of 80 and 20.

On this chart I see potential support coming in near 1582.0, the 18-Day Moving Average of Closing Prices.

The Slow Stochastics Study remains bullish. Let’s assume the “K” Line, the red line that makes up part of the study turns down under 80. If it were to do so my downside projection would be a test of the 18-Day Moving Average of Closing Prices.

Let’s assume this doesn’t occur. If this were the case prices could drop a bit, but in order for the study to stay embedded the price break would need to be very shallow and limited in time.

The Swingline Study, the “brown line”, continues at this point in time making new highs. The last low of 1480 is the number I don’t expect to be taken out anytime soon if this leg of the bull market is going to last. A correction to establish a higher low than 1480 is what would normal and what I hope to be by the end of August. Support on this chart is at 1522.9, the 18-Week Moving Average of Closing Prices.

For those of you that follow my Twice Daily Trade Recommendations, today was the day that I recommended you get out of your most recent long position. This means you are looking for directions from me on what to do next.

Early August is often the point in time where the market sets back a bit and by month’s end in bull market years, starts to accelerate upward by month’s end. The end of August through the end of September has been a seasonally strong time for higher gold prices.

I don’t see anything other than knee jerk reactions on the horizon that will change gold’s uptrend. This includes market uncertainty, sovereign debt issues, political noise and so on. Therefore, I think that if Congress does reach some type of agreement, gold may fall on that announcement. That break will in my opinion be a buying opportunity.

Assuming no agreement is reached, I still think gold may break a bit if stock prices tumble and investors initially sell other assets to hold onto their stocks, meet margin calls or simply want to be in cash as they did in 2008. That break will present a buying opportunity.

Last, let’s go back to the seasonal percentage gains I talk about at the beginning of this report and lets say that “you” buy into this thinking. One way to play this thinking would be a Vertical Call Spread. Using this strategy you would look to be a buyer based on where the market finishes on this coming Friday and assume that by year end, prices were higher than they now are. Let’s assume prices close the week out at $1600. 

·         Assuming prices “gain” 5% by end of December, $1680 is a target price.

·         Assuming prices “gain” 10% by end of December, $1760 is a target price.

Keep in mind that prices can lose and can spike all over the place. They did so in 2008, but in that year prices had not hit all-time highs, which I think important in using this strategy. However, there was a financial meltdown and if Europe or the US were to do something completely crazy, that could occur again. I am not of that mindset, but am aware that these are unusual times and so should you.

A way to limit risk is to play a Vertical Call Spread. This is an option play where you buy a Call and sell a higher Call Option against it. This limits both the profit and loss side of this strategy. You cost is limited to the cost of the option you buy less the premium of the higher strike Call Option you sell short, in addition to commissions and trading fees. The profit is capped at the difference of the spread in the strike prices less your net cost of the Call Spread.

My thoughts right now are centering on the 1550 up to the 1650 December Calls as the long side of the spread and the 1700 to 1750 December Call as the short side. Given a large enough price break in early August, I might even recommend buying just the Call side first and waiting for a rally to sell the higher Call Option. You’ll simply have to wait until I recommend pulling the trigger to see what I come up with.

I expect to also be providing futures recommendations as well. Those will be available in my Twice Daily Trade Recommendation Reports.

For those who want to follow my trade recommendations you might wish to consider doing so by clicking here.

Call 1-866-973-2077.

Disclaimer: This publication is strictly the opinion of its writer and is intended solely for informative purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is taken from sources believed to be reliable, but is in no way guaranteed. Chart data is courtesy of LGP-IraCharts. No guarantee of any kind is implied or possible where projections of future conditions are attempted. Futures and Options on Futures trading involve risk. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from The Ira Epstein Division of The Linn Group, Inc. or The Linn Group, Inc. that you will profit or that losses can or will be limited in any manner whatsoever. No such promises, guarantees or implications are given. Past results are not indicative of future performance.

-- Posted Friday, 29 July 2011 | Digg This Article