Despite Setbacks, Gold Rally Marches On

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"The cause of the recent volatility is Friday, December 18th's quadruple witching. . .this only happens once every three months."

Gold had a horrendous day on Thursday, December 17th, with the price dropping below $1,100 for the first time in many weeks. In mid-day trading in New York, there was a sudden vertical drop that was bound to give most investors pause. While gold went up almost every day in November, it has been mostly on a downward path since the beginning of December. Does this mean the gold rally is over? No, not at all. It just means that gold doesn't go up every day.

The cause of the recent volatility is Friday, December 18th's quadruple witching. Stock index futures, stock index options, stock options and single stock futures all expire on the same day in a quadruple witch and this only happens once every three months. The impact of the expiration can frequently be seen a day or two before, and that is what investors were witnessing on Thursday. Prices will tend to move to minimize the value of the outstanding options. The big trading houses are major options sellers and they lose a lot of money, if this doesn't happen. This has been an important factor lately in driving gold down and the U.S. dollar up.

The bears, of course, have been claiming the gold rally is over. The price action we are seeing now is reminiscent of the pullback in December 2007. GLD, the major gold ETF, broke the 50-day moving average line then, just as it did now on December 17th. Gold had trouble rallying for four weeks during the month, but then the second phase of the rally followed. This took GLD up to much higher highs before it peaked in March. January and February are traditionally two of the strongest months for gold.

Even if there is some pause to the rally, nothing has changed in the longer-term picture. As long as there is easy money from the Fed—and raising interest rates from zero to a half a point or even a point or more—is still easy money and the federal government continues its spending spree, the backdrop for a gold rally is still in place. Don't expect this to change any time soon.

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