Has Gold Begun to Correct?

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So far, 2014 has been an excellent year for the gold price, which is up over 13 percent, and gold mining equities are up about twice that. We began the year with extreme pessimism in the gold market, but a spike in gold prices was inevitable.

But now it seems that market sentiment has shifted somewhat. While there are still a lot of gold bears out there, we are starting to see more bullish calls, especially given the tensions we are seeing in the Ukraine. In fact, there are several analysts who believe that tension in the Ukraine is going to catapult gold higher. This reached a mild point of euphoria — something we haven’t seen in the gold market since 2011 — with pieces such as this one claiming that gold would rise an incredible 10 percent – 20 percent this week on news of a Russian incursion into Crimea.

We saw that on Sunday Crimeans voted to join Russia, and we learned just recently that the U.S. and the EU will be imposing sanctions on Russia. These events are clearly in-line with this bullish euphoria that has entered the gold market.

But what happened to the gold price? While we saw gold rise Sunday night (Monday morning in Asia) to $1,390/ounce, it fell back to $1,365/ounce as trading closed in the U.S. on Monday afternoon. Furthermore, we saw high volume in the SPDR Gold Trust (NYSEARCA:GLD), which gives validity to the move lower. We also saw a sharp sell-off in the shares of gold miners. The Market Vectors Gold Miner ETF (NYSEARCA:GDX) fell by over 3 percent on 57 million shares versus an average of just 36 million shares. If we look at some individual mining companies we see some very sharp declines. New Gold (NYSEMKT:NGD) shares fell by nearly 8 percent and Kinross Gold shares fell by nearly 5 percent.

The list goes on, but the point is made — a lot of money is exiting these stocks. This is not surprising considering that a lot of money entered these same stocks over the past few weeks, and given the strong performance we saw from gold and related miners toward the beginning of the year, I think a lot of this money was chasing performance and these traders were prepared to exit the market on any short term weakness such as what we saw today.

Looking at the gold price longer term, the uptrend that began in January is still in place, but I think we need to see a correction to the lower $1,300s before gold is worth buying again. Longer term, investors should consider waiting for even lower prices — around $1,270, especially if they already have a sizeable position.

More aggressive investors should consider taking a position in gold mining companies. As prices come down, the shares of these companies will almost certainly over-correct, and this correction can be steep. Keep in mind that some of these stocks are already up as much as 40 percent or more for the year, and it wouldn’t be unusual if these companies were to lose half of their gains.

But with that in mind, I think a lot of opportunities are going to emerge in the next few weeks and the uptrend should continue. Given the anticipated volatility in gold and in gold miners, investors should use limit orders or sell put options in order to take positions as this will take the emotion out of the trade.

I should note that while the $25/ounce swing we saw in the gold price seems large it really isn’t, and while it looks to be the beginning of a longer correction this intuition could be wrong. For this reason, I am not selling any of my gold and I am not taking any short positions in gold. There is still a very real possibility that economic weakness, geopolitical tension, and an easy monetary policy coming from the Federal Reserve will drive the gold price higher. But investors need to tread lightly.

Disclosure: Ben is long shares of Kinross Gold.