Buying gold at these levels (between $1550-$1580) has excellent risk-reward potential, which could be one of the best trades right now!
The price of gold has been in a short-term downtrend, which actually caused bearish sentiment on gold. However, as we show in Figure 1, the weekly chart of June contract of gold futures shows that gold has been in fact in a longer-term range bound trade between $1550-$1800. Now, we are at the bottom of that range!
Thus, technically, buying gold at these levels makes sense from as a swing trade perspective. A stop loss order at $1550 risks $20-$40 an ounce depending on actual buying price and the stop loss fill, if the support level is broken. At the same time, if the support level holds, the profit potential is $200-230 per ounce if the gold revisits the resistance level at around $1800.
How do you justify the long-gold trade fundamentally? The fundamentals for gold improved recently! We look at the federal funds futures as a proxy for economic recovery. Based on the current economic forecast embedded in the federal funds futures, the Fed is going to increase the interest rates to 50 basis points in Oct of 2015, which officially ends the current crisis. Thus, is safe to say that there is no end in sight of the current economic crisis – Oct 2015 is almost two and a half years from now. Further, as figure 2 shows, the federal funds futures actually got more bearish recently, as the stock market reached all time highs! That tells you that the stock market is disconnected with the economic reality, and we can expect flight to safety to gold soon. Further, the crisis in Europe has not reached the worst level yet, as the recent Cyprus situation shows. Thus, buying gold fundamentally makes even more sense.
In summary, technically, gold is at the bottom of the range, while gold fundamentals even improved recently. Thus, gold might be the best trade right now.
Figure 1. Gold futures -June contract.
Figure 2. Federal funds futures – Oct. 2015 contract. The implied Fed rate is 100 minus the current price. Thus, as price increases, the interest rate decreases. Current implied interest rate is 50 basis points, and it was 66 basis points earlier in March – thus the bearish economic downgrade