Gold: Going Higher Or About To Pop?
Graham Summers
December 22, 2009
I get more emails and questions about Gold than any other investment class on the planet. With that in mind, I wanted to take a few minutes today to map out my thoughts on this subject.
For starters, we need to consider that there are, in fact, two types of Gold: actual physical bullion OR paper Gold (Gold as represented by an ETF or futures contract)
While both of these investments are called "Gold" in common conversation, the fact of the matter is that they are very different in several striking ways. I've mapped out a few of the differences in the table below:
As you can see, there are quite a few noticeable differences, mostly concerning liquidity (a lot vs. not as much) and manipulation (ditto). However, the key item for me is that physical bullion is something YOU own, whereas buying an ETF requires you to TRUST that the ETF owns gold.
Indeed, several investment commentators have made allegations that the Gold ETF (GLD) is not actually backed by physical Gold. Personally I have no insight on this issue. But in my opinion, if you're going to buy Gold, you should actually OWN Gold rather than trusting a bank to own if FOR YOU (given how trustworthy the banks have proven to be). This means buying actual bullion NOT an ETF (though if you want to trade the ETF that's probably fine).
So where is Gold going from here?
This actually is a VERY tricky subject to analyze because there is such a confluence of factors. Indeed, even if we go from what history shows us, we get mixed messages.
For starters, Gold has outperformed every asset class on the planet for the last 10 years. The last bull market in Gold was roughly ten years, running from 1970 to 1980. So strictly looking at Gold from a timing perspective (with no eye to fundamentals, inflation forecasts, etc.) this current Bull market is looking a little long of tooth.
In contrast, from a gains perspective, Gold looks like it's just getting started. During the last bull market in gold, the precious metal rose 2,329% from a low of $35 in 1970 to a high of $850 in 1980. From mid-1971 to December 1974, gold rose 471%. It then fell 50% from December '74 to August '76. After that, it began its next leg up, exploding 750% higher from August '76 to January 1980.
In its current bull market (2000 to today) Gold has followed a similar pattern albeit at a much slower pace. The precious metal took nearly twice as long to complete its first leg up (2000-2007) rallying 300+% ($250 to $1,032).
Then, just like during the last Gold bull market, the precious metal staged an 18-month correction (Feb 2007-September 2009) though this time around it only fell 30% rather than the full 50% retracement in the '70s. Gold then erupted into its second major leg up a few months ago, tearing through the $1,000 price point and soaring to over $1,200+.
Here's a chart detailing the two decades:
If Gold were to follow the historic trends of its last Bull Market, one could argue, from a gains perspective, that the precious metal has only JUST begun its second leg higher. And if history is any guide, THIS leg will be the BIG one (last time around Gold rallied 750% which would forecast a move to $7,000+ per ounce in today's Dollars).
Thus, right off the bat, history is showing us two very different points of view. In terms of timing, this current Gold bull market is looking pretty old (if history serves as a guide it will end in 2011). However, from a historic gains perspective, Gold's bull market is still very much in its infancy.
Forecasting Gold from a supply/ demand perspective is no easier. For one thing, actual physical demand for Gold is PLUMMETING despite the metal rising to new all-time highs. According to the World Gold Council, year over year demand for Gold has fallen ACROSS the board:
All told, total physical demand for bullion has fallen 35% in the last 12 months. This is absolutely STAGGERING when you consider that the precious metal has rallied 20% over the same time period.
It's actually quite odd. Demand for physical Gold was off the charts at the beginning of this year, with 1,041 tons of Gold sold in 1Q09 alone (the second highest quarter in the last three years). However, during the last six months, demand has fallen off a cliff plunging to 728 tons in 2Q09 and then 802 tons in 3Q09 (a 22% from 1Q09 levels).
Indeed, we need to see an absolute blockbuster in Gold demand this quarter (1,250+ tons) for 2009 to even match 2008's levels. The likelihood of this is small considering that total physical Gold demand is down some 35% year over year for the last quarter.
Looking at the above data, it's clear that Gold is now trading based on speculation, not fundamental demand (much like oil in 2008) and consequently has entered a sort of bubble or mini-bubble stage. This, of course, could change suddenly if physical demand picked up, but for the moment, Gold is in a kind of speculative frenzy, trading 20% higher than it was last year despite a 35% drop in physical demand.
This is a bit of a red flag for the Gold bulls. In order for Gold NOT to be in a bubble we need to see a sharp pick up in physical demand. Otherwise we're getting into the same territory that Oil entered in 2008: a massive rally that can reverse as rapidly as it rose. Looking at how rapidly Gold reversed in the last couple of weeks, this is a distinct possibility.
This scenario can of course change at any time should the public's demand for physical bullion pick up again. However, until that occurs, Gold is in the same phase that Oil was in 2008: a speculative market in which sharp rallies or corrections can occur at any time.
With that in mind, we're finally looking at Gold from a technical analysis perspective to get some insights into where the precious metal is heading in the near future.
Back in early November, I wrote that Gold's latest rise was largely on the back of Dollar devaluation. One of the primary reasons I wrote this was because the precious metal had failed to hit new highs against other major currencies.
That situation has since changed. Gold has hit a new high against the Euro:
The Japanese Yen:
And the Swiss Franc:
However, as it did this, Gold became extremely over-extended from its 50-, 200-, and 340-DMAs. Indeed, by the time Gold had broken to new highs against other major currencies, it was due for a serious correction.
Bill King of the King Report notes that previously, any time Gold rose 40% above its 340-DMA, it suffered a steep decline soon after. King writes:
Gold got 40% above its 350-day moving average on May 15, 2006; it fell from 720 to 542 in one month. Gold also got 40% above its key moving average on 3/17/08; it declined from 1032 to 682 by 10/24/08.
At the beginning of December 2009, Gold (priced in Dollars) was 34% above its 340-DMA. So it wasn't quite at the 40% level seen in March '06 or March '08, but it was getting close.
Sure enough, soon after this, Gold staged a serious correction, falling to test its 50-DMA in a few weeks. As an aside, I'd like to point out that this sudden reversal is typical of markets driven by speculation.
So what's next?
Well, first of all, Gold looks to have bounced before it even hit its 50-DMA. This is extremely positive from a momentum standpoint since Gold didn't even fully fall to test the 50-DMA.
The culprit for this sudden correction? A sharp Dollar reversal and rally:
As you can see, the Dollar has broken its 50-DMA with no problem and is now facing resistance at 77. This marks a break in the Dollar's nine-month downtrend. As such it is a MAJOR reversal (as confirmed by the break above the 50-DMA) and likely the beginning of an sustained uptrend in the Dollar.
Thus, all eyes should be on how Gold performs in the next few weeks. As noted before, Gold has thus far managed to avoid a full test of its 50-DMA. However, this could easily change as the Dollar rally gains momentum. IF Gold breaks below the 50-DMA then the next lines of support are $1,050, $1,025, $1,000 and finally the 200-DMA ($983). I've drawn them in below.
This wraps up our analysis of Gold for this week. All in all the main points to take away are:
- Gold is currently being driven by speculation (not real physical demand), as such, it is prone to sharp rallies AND reversals.
- Gold has hit new highs against non-Dollar major world currencies which is indicative of a flight from paper currency in general as opposed to Dollar devaluation.
- Gold has entered a sharp corrective phase but has thus far has managed to remain above its 50-DMA despite the Dollar rallying sharply. This indicates that the upward momentum is still VERY strong.
The issue now is how Gold performs as the Dollar rally intensifies. If Gold remains ABOVE its 50-DMA then we're looking towards bigger gains in the near-term. However, if Gold DOESN'T stay above 50-DMA, then we're likely going to see a test of $1,050 or $1,025. Indeed, Gold could even test its 200-DMA ($983) and STILL be in a bull market.
Again, keep your eyes on Gold in relation to the Dollar.
Good Investing!
Graham Summers
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