by Marc Lichtenfeld, Healthcare Expert
Wednesday, December 9, 2009: Issue #1154

Now is the time to take profits on gold – at least on a temporary basis.

I’m sure I’m going to hear it from the gold bugs now, but my colleague Karim Rahemtulla is right on the money with his assessment of gold.

There’s just too much evidence that gold is in the early stages of consolidation. Let me explain why…

Gold Prices Heading Down the Dot Com Path?

What supports my assertion that gold prices are headed lower in the near-term? Both behavioral and technical factors…

• Behavioral

Think back to the dot com bubble in 1999 and 2000 when all anyone could talk about was the stock market. Today, we’ve got a similar situation in the gold market.

It’s not just financial/business shows talking about gold. Mainstream news shows are covering the topic, too. Typically, they rarely mention the financial markets (unless there’s a crisis). After all, there’s too much other valuable information to share with the American public, like the newest woman to say she slept with Tiger Woods or who Reese Witherspoon is dating.

When a financial instrument becomes the topic of mainstream news, that’s often a sign of the top.

Also consider that hedge fund manager John Paulson is making a huge bet on gold…

• His firm, Paulson & Co., own nearly 43 million shares of gold miner AngloGold Ahsanti (NYSE: AU) – 12% of the company.
• The firm also owns 31 million shares of Kinross Gold (NYSE: KGC) – 4% of the company.
• Paulson is the largest owner of the gold ETF, SPDR Gold Shares (NYSE: GLD), boasting 31.5 million shares. The fund is a proxy for gold, as it tracks the price of the metal.

Paulson is so bullish on gold that he believes the metal is heading for $4,000 per ounce. And he’s starting a new gold fund in January. Remember, Paulson is the investor who correctly bet on the housing collapse and made billions.

However, as I told Mt. Vernon Research members last week, while Paulson’s housing trade was brilliant, very few investors who have made big calls like Paulson’s are able to do it again.

Still, Paulson is putting about $250 million of his own money into the fund. That smells a lot like a top for gold.

Now, onto the technicals…

Why Technical Analysis Points to a Drop for Gold Prices

John Roque, a technical analyst at WJB Capital Group, points out that gold has reached a +2 standard deviation above its 200-day moving average.

What does this mean?

• 200-Day Moving Average: This is simply the average price over the past 200 days.
• Standard Deviation: If you don’t remember this from your statistics class, standard deviation is how much variation there is from the average (think of it as a bell curve).

A +1 standard deviation of any event occurs roughly 31% of time, while a +2 only happens 5% of the time (the flat line of the bell curve).

So in other words, a +2 standard deviation is a fairly extreme measurement. And in this case, it signals that gold is overbought.

But here’s the rub: Since 2006, gold has hit a +2 standard deviation on two other occasions – and the price fell by 22% and 29% respectively.

There’s another important indicator, too…

What the “Skew” and “Smart Money” Shows Us

Another indicator that shows gold is richly valued is the “skew” on options. Skew is simply the difference in volatility between call and put options that have the same strike price and expiration.

This week’s edition of Barron’s mentioned that the volatility of the SPDR Gold Shares ETF is higher for out-of-the-money puts than it is for calls. Just two months ago, it was the opposite. This suggests that people are buying more downside protection by way of put options than trying to take advantage of price appreciation with calls.

Action in the options market is often called the “smart money.” Investors will often look to the options market to get an idea of where the “smart money” thinks the market is going. In this case, the “smart money” is getting increasingly cautious on gold.

Since gold is still used for industrial purposes and jewelry, some gold bugs point to the supply-demand equation in support of higher prices. However, it’s important to note that the gold ETF is now the sixth-largest holder of physical gold. So if we see a gold selloff, the ETF could accelerate the decline with the disposal of its physical gold.

As Karim noted yesterday, gold prices shot up in a straight line over the course of a couple of months – from $1,000 per ounce to over $1,200. I expect to see a correction back down to at least $1,000 in the near future.

Hoping your longs go up and your shorts go down,

Marc Lichtenfeld

View original at: Investment U

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