Dorn: Going For The Gold?

Amid the apparent carnage on Friday, behavioral traders noted that some of the gold stocks did something interesting. They closed higher than they opened. FCX, often touted as the leading indictor for gold stocks, made this kind of move. Also, the gold futures basis December bounced nicely from their 200 period moving average.

If this pattern continues on Monday, we could, at some point over the next 5-10 trading days, see massive short-covering and buying in the gold futures market with jumps in price that could be breathtaking and likely to catch many by surprise. This is because the so-called “weak sisters” in the gold markets have sold in disgust, leaving the strong hands in control. No one is talking much about gold doing anything but going down, so we are interested in it. Physical demand for gold worldwide is enormous with people willing to pay considerable premiums over the spot price.

This is another anomaly with behavioral ramifications. Thus, the forced selling, unwinding of currency carry trades and deleveraging that hit the futures market is not being reflected in the demand for physical metal. Futures, it must be remembered, are fiat. The physical metal is a hard asset that, for many, represents insurance, a store of value and what is called “honest money.”

The dollar is ready to fall again. It has risen too far and too fast, and needs to take a rest before it decides what to do next. It is only a matter of time before the massive amounts of money being printed come home to roost. If the inverse relationship between gold and the dollar continues, gold will take off at the first sniff that the dollar is about to retrace its recent gains. Gold has a very keen sense of smell, and it sniffed this on Friday and started to move up.

The next few weeks in the gold markets have the potential to be of the shock and awe nature. Once again, those that sold at the lows because they could not take the pain will be wallowing in regret and not know where or how to get back in. They likely won’t believe what they see. At that point, every manner of stinking thinking (aka pathological defense mechanisms) will set in an attempt to cushion the pain, shield from regret and—in a convoluted way—generate pride. The worst lies are the lies we tell ourselves, and this very human trait is one reason that so many traders fail.

Dr. Dorn holds a position in the December gold futures electronic contract at the time of this writing: October 27, 2008 11:40AM EST.

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Janice Dorn, M.D., Ph.D., is a financial psychiatrist and chief global risk strategist for Ingenieux Wealth Management in Sydney, Australia. She also offer trading consulting and coaching services via her Web site, TheTradingDoctor.com.