Gold glitters -- not

The gold exchange-traded funds -- GLD and IAU -- broke above their 20-day price channels on Thursday. The bull signals were confirmed as the funds traded above their breakout levels today.

GLD and IAU both track gold bullion. GLD has a higher fee and also higher liquidity. IAU is less liquid and has a lower fee.

Liquidity is a necessity for a relatively short-term trader like me, so I will focus on GLD in this discussion. The funds' charts are barely distinguishable. They're a pair, like Tweedledum and Tweedledee.

Everyone knows the story of GLD -- the store of value against inflation, the best place to park emergency cash to buy food when the Zombie Wars begin, the best loved vehicle of wealth both in India and the Texas home of former presidential candidate Ron Paul.

To its fans, gold is the only real money. The rest is just government trash.

Gold was cheap when the GLD fund began trading in 2004, had more than quadrupled in price when it peaked in September 2011, and since has lost a third of its value.

GLD 8 years weekly bars (left), 90 days 4-hour bars (right)

The Elliott wave count clearly shows GLD in a downward correction from its peak, with wave 4 to the downside possibly taking the form of a zig-zag or a flat..

If it is a zig-zag, then the present wave b up will fall short of the the $138.17 peak; if a flat, then it will likely return to those levels.

For a trader who makes a living by following trends, the chart makes it clear that a bull play on GLD is a counter-trend trade.

A flat construction for waves a and b might well result in a 6% gain, but a zig-zag could reverse this afternoon or Monday. The ensuing wave c will show great momentum to the downside, if Elliott wave doctrine holds true.

There's nothing in the chart to tell me which form is most likely, and so faced with the chance of an energetic wave c to the downside, an upside trade is a risk I'm unwilling to take.

IAU was one of eight symbols that survived my initial screening overnight. (See "Friday's Prospects".) GLD was not a survivor because its average net gain on bull trades was under 3%.

Two construction funds, ITB and XHB, also gave bull signals. XHB failed confirmation and ITB isn't showing upside momentum to follow through.

The other symbols are all stocks.

Of the upside breakouts, KMI has a bearish trend, DOV failed confirmation, and RH and ENL aren't showing upside momentum.

The one downside breakout, RMBS, has options, but the spread is too wide to meet my trading preferences.

GLD on average trades 7.5 million shares a day and supports an awesomely wide selection of option strike prices spaced a dollar apart, with four- and five-figure open interest near the money with a front-month at-the-money bid ask spread of only 1.1%.

IAU trades 3.7 million shares a day and has a moderate selection of strike prices with three-figure open interest near the money and a very wide bid/ask spread of 50%.

Implied volatility for GLD stands at 20% and for IAU, at 19%. Each is at the low point of  its six-month range and has been falling since mid-October.

GLD options are pricing in confidence that 68.2% of trades will fall between $122.42 and $137.50 over the next month, for a potential gain or loss of 5.8%, and between $126.34 and $133.58 over the next week.

The equivalent figures for IAU are a one month range of $12.33 to $13.81 for a potential gain or loss of 5.7%, and a one-week range of $12.71 to $13.43.

Contracts on both are trading below their five-day average volumes with a skew toward calls. GLD is running at 83% of average for calls and 64% for puts. IAU is running at 51% for calls and 21% for puts.

Decision for my account: No trade in either fund, based on the charts. By being cautious, I'll avoid the wave c collapse if it happens. Of course, I'll be doomed when the Zombie Wars begin, proving yet again that in trading, everything is a trade-off.

References

My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading. 

By preference I place my trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.