Why You Should Look for Gold to Correct Again

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I am extremely bullish on gold. I think the price could climb dramatically from the current $1,320 per ounce price. However, having a position already, I can be selective in when I choose to add to my position. While last week’s surge generated a lot of investor enthusiasm for the yellow metal, I am not so sure that we are out of the woods. I am not selling what I own, but I am also not adding at this point.

While Tuesday was a relatively quiet day for gold, when we look simply at spot price fluctuations, we saw some wild swings in the mining shares that leave me nervous. The Market Vectors Gold Miner ETF (NYSEARCA:GDX), which holds a basket of the world’s largest gold mining companies, had what traders call an “outside day.” This means that the fund opened Wednesday’s trading session higher than Tuesday’s closing price, and it closed lower than Tuesday’s opening price. The idea here is that while the market looked relatively positive on Tuesday, it brought in selling on Wednesday that was too large to be overcome by the bulls.

The GDX traded as high as $26.53 and it closed at $25.47, or about 1 percent above the low. This wild swing suggests to me that we could be setting up for a correction in this fund. This is to be expected, considering the incredible price increase we have seen thus far in June, with the fund trading up from about $22 per share to over $26 per share for about a 20 percent return in just a few weeks. Anytime we see this sort of gain in any market, we should expect some sort of correction. Right now, there is strong support at around the $24 per share level, and I expect the shares to trade down here in the next few days.

This is bearish for gold because mining shares often lead gold itself. So-called “smart money” traders who follow the gold market want to leverage their positions, and they do so by buying and selling mining stocks.

Keep in mind that the profits of a mining company are based on the price of gold minus the cost of producing it, and so any swing in the gold price is magnified with these gold stocks. This is especially true considering that production costs in today’s market are typically in excess of $1,000 per ounce, which means gold miner’s profits are leveraged about 4-to-1 to the gold price.

As a result, we see gold miners switch course a little before the gold price. This happened in May before the market turned higher, and also in December and January, when the market turned higher.

Therefore, the fact that the gold miners traded down 3 percent while the gold price was essentially flat should get the attention of short-term traders and of long-term investors who are looking to put money to work in the sector. Investors should consider holding off in anticipation of a correction in the gold price, perhaps back to the $1,275 per ounce level.

Furthermore, investors might want to consider taking profits in some of the gold miners and related stocks that hit 52-week highs on Wednesday, and there were plenty of them, including Franco Nevada Corp. (NYSE:FNV) and Agnico-Eagle Mines (NYSE:AEM). These may be the leaders going forward, but we can easily see sharp corrections in these names, and investors should be ready for this.

Ultimately, the price of gold is going to move much higher considering the increased demand from Asia and the decline of the U.S. dollar in both global significance and in purchasing power thanks to the Federal Reserve’s unprecedented quantitative easing programs. But that doesn’t mean that the gold price will run up in a straight line. There are going to be numerous corrections along the way, and these are the buying opportunities.

Disclosure: Ben Kramer-Miller owns gold coins and shares in select gold mining companies.

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