Sentiment extremes, regardless of whether they’re bullish or bearish, invariably point to a readjustment in prices. This undeniable truth applies to all asset classes in all time frames. Nothing is immune to the forces of crowd behavior. (See Beanie Babies and Pokemon cards)
On Jan.23, 2015 the Wall Street Journal declared “Buyers Take a Shine to Metals Again.” When this headline was published, the SPDR Gold Shares (NYSEARCA:GLD), which follows the price of gold bullion, had jumped 9.38% against a modest loss of 0.28% for the S&P 500 (NYSEARCA:SPY).
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Since Aug. 2011, gold prices have crashed 28%, so naturally, enthusiasm for a rally – especially among survivalists and Peter Schiff groupies, has been building.
The WSJ article correctly observed how the amount of gold owned by exchange-traded products (ETPs) jumped by more than 1.2 million ounces in January, making it the biggest increase since Aug. 2012. Likewise, silver coins (NYSEARCA:SLV) sales have been rising.
Just as bullish enthusiasm for gold (NYSEARCA:UGL) was peaking, the Feb. 2015 ETF Profit Strategy Newsletter (released on 1/24/15) alerted readers:
“Ahead of a potential pullback, we’re buying the ProShares UltraShort Gold (NYSEARCA:GLL) at $83.75 up to a buy limit of $84.25. GLL aims for double daily opposite performance to gold bullion. Our tandem options trade is to buy the GLD MAR 2015 124 put options (GLD150320P00124000) at $350 up to a buy limit of $375.”
We bagged a +32% one-week gain on the GLD calls and our GLL position is already +10% higher from where we bought it. Not only did we understand the market dynamic of sentiment extremes, but we took advantage of it. These principles used in conjunction with technicals can be applied in any market, not just metals (NYSEARCA:GLTR).
The chart above illustrates how capitalizing on short term overly bullish extremes in gold (NYSEARCA:GDXJ) has been great for contrarian traders. The red dotted line coincides with GLD’s yearly top (so far) and is where we executed our bearish gold trade. It also reinforces an age old truth: Do the opposite of the crowd and you’ll always get what they wish they had.