Gold plummeted $30 an ounce in less than a minute but – unlike previous times when big sell orders like this started avalanches of new selling, gold quickly recovered traded higher on the day. We saw this as the first sign that most of the weak holders were already out of the market, having sold to lock in tax losses for 2013.

Daily Gold Values

But the technical picture is not the only reason we like gold here…

Three More Reasons Gold Could Rally

1) Physical supplies on both the Comex are dropping to dangerous levels — warehouse stocks of deliverable gold are now at low enough levels that a “short squeeze” is possible. Short Squeezes occur when holders of long futures contracts decide to take delivery of the physical metal rather than exiting their positions prior to the delivery period.

If there is not enough metal to make delivery, holders of short futures positions will be forced to buy back their short contracts. This can lead to a melt up in prices. If this occurs, those not in the market already probably won’t get a chance to get in – at least not at a reasonable price. Premiums for physical gold will go through the roof.

Comex Gold Inventories

2) JP Morgan and other “manipulators” have reduced short positions and are flirting with getting long. There is a whole industry that has grown up around the notion that the COMEX gold market is manipulated and that the reason gold hasn’t skyrocketed to the moon is because of a cabal of big banks doing the nefarious bidding of the government – selling into rallies and raining on the bulls golden parade. When these “big, bad banks” start buying back their shorts, it is probably time to sit up and take notice.

Gold Monthly

3) Gold is oversold long term and still in an uptrend. Gold’s 2013 collapse could be corrective. The chart below shows the Midas metal testing its long term trend line. It would take a series of close below $1,150 to negate this uptrend. We will use two consecutive lower closes below $1,150 as our risk point.

What to Do Now

It certainly doesn’t happen every year but late winter and spring can be friendly seasons for gold. Consequently, we want to construct a fixed risk trade that gives us bullish exposure to this market for at least the next five months. Our price targets are $1,360 (up 9%), $1457 (up 16%), and possibly $1,660 (up 33%).

We are currently recommending bullish spread plays in gold options. Our most aggressive play currently has a maximum risk of $1,200 plus transaction costs and a gross profit potential of $10,000 should gold hit our middle target prior to June option Expiration on May 27, 2014. Our brokers can also custom design similar positions with lower risk profiles and flexible price targets to fit differing risk tolerance levels. Each “spread” we buy covers 100 ounces of gold with an underlying contract value (currently) of $126,000.

Lindsay Hall, RMB Group

View Webinar

In a recent webinar with RMB Group clients, I presented this information in a webinar. You can view the recorded webinar on-demand here.

More Information About This Strategy

RMB Group trading customers interested in this strategy should contact their brokers for a specific recommendation. If you are not an RMB Trading Customer, give us a call at 800-345-7026 (toll free) or 312-373-4970 (direct) and we’d be happy to go over this strategy with you. Contact us online or e-mail Put the words “gold play” in the subject line and we will contact you about this idea.