Looking at Gold’s monthly chart below from 1999 to the present, you can see that gold’s been in a steady uptrend since 2002.
GOLD MONTHLY CHART NOV. 2001 – JAN 2012 01 jan 12 1658
The current 5 month downtrend (begun in September 2011) has brought predictions that gold’s run is over, and calls that gold’s rise is yet another asset bubble ready to burst. Is it? Clearly investor confidence has Here’s the evidence pro and con.
1. Background: The Key To Understanding How Gold Performs
See separate post: The Secret To What Really Drives Gold Prices
2. Why Gold Headed Lower
The arguments that gold’s downtrend has more room to run include:
A. TECHNICAL PERSPECTIVE
1. The Long Term Monthly Chart: That Which Goes Up Must Come Down?
Certainly from a technical analysis viewpoint this makes sense. As the long term monthly chart below shows, gold has hardly even seen much of a normal technical correction since its decade long march higher began accelerating around November 2005. It’s due for a more substantial pullback than it’s had thus far. As we note below in our discussion of gold’s fundamentals, public and private sector deleveraging favours a deflationary environment that would undermine demand for gold and provide the fundamental fuel for a deeper pullback.
GOLD MONTHLY CHART NOV 2003 — JAN 2012 03 jan 12 2010
Note from the monthly chart above:
- Gold hasn’t even retraced to its 23.6% Fibonacci retracement for the rally that began in November 2005 (blue set of Fib retracements).
- Gold hasn’t even retraced to its 38.2% Fibonacci retracement for the most recent leg of the rally that began in October 2009 (yellow set of Fib retracements).
- Gold still hasn’t even decisively exited its Double Bollinger Band Buy Zone, so its long term uptrend isn’t even in real pullback mode yet.
Granted however, one could look at the 3 points above from a bullish perspective – the long term trend has yet to break down.
2. The Long Term Weekly Chart: Downtrend Well Established
Here’s gold’s weekly chart. It still provides a 2+ year perspective but with somewhat better resolution.
GOLD WEEKLY CHART NOV 2008 — JAN 2011 05jan 12 2220
The overall picture is mixed but more bearish for the coming months.
Bearish: The 19 week downtrend is firmly in place and has held through 4 serious tests during November to early December 2011 (ellipsis A). Also the 10 (blue) and 20 (yellow) week EMAs have turned down, with the 10 week EMA poised to cross below the 20 week EMA, a distinctly bearish sign that would further confirm the downtrend begun in September.
Also, 5 weeks ago gold broke below its long term trend line (dotted orange line). If it doesn’t get back above it soon, a test of the 1550 — 1450 area is likely.
Bullish: Looking at the weekly chart above: neither the 50 week EMA (red) nor the 20 week EMA (yellow) has been decisively breached. The area between these has been firm support for gold since late 2008. Also, gold has already bounced above the Double Bollinger Band Sell Zone, signaling an end to the strong downward momentum.
Bottom Line: So far the technical picture shows nothing more than a 5 month downturn. We’ve seen a number of those, even an 8 month pullback, since gold’s decade long uptrend really began accelerating back in 2005. If the past decade is any guide, these are buying opportunities. As we discuss below, the balance of fundamental evidence also favours more upside in the coming years.
B. FUNDAMENTAL PERSPECTIVE: DEFLATION IS MORE LIKELY THAN INFLATION
This is true as long as the global economy remains in deleveraging mode, with both public and private sectors seek to cut debt, that puts a damper on lending and spending no matter how much cash the Fed and ECB makes available. Thus far, the history of the Great Financial Crisis supports this viewpoint. Inflation has stayed quiescent despite historically low rates and loose monetary policy in the US, EU, and Japan. China and the UK are also heading in this direction.
Deflationary conditions discourage owning gold. This bias towards deflation over the coming years is the most potent argument for gold being flat to lower over the coming years.
3. Why Gold’s Going Higher
While deflation could pressure gold, remember that inflation has also been low in recent years, and that hasn’t stopped gold’s current rally (fuelled by fear of potential inflation only). Meanwhile, fundamentals behind the current long term rally are still in place, suggesting that gold’s heading higher, possibly much higher.
A. TECHNICAL PICTURE: LONG TERM UPTREND INTACT
As noted above, the longer term technical picture for gold on both its monthly and weekly charts suggests that the longer term uptrend remains intact. So far, the current 5 month dip is just another multi-month pullback like we’ve seen a number of times over gold’s decade long rally.
B. FUNDAMENTAL PICTURE
Gold’s bullish fundamentals include:
1. Continued Central Bank Loose Money Policies
The central banks of most major economies, the Fed, ECB, BoJ, PBOC, and BoE among them, remain in easing mode. While it’s unclear whether the Fed will initiate QE 3 any time soon, the ECB has been aggressively easing via both rates and its recent LOTR program. More significantly, if the EU wants to keep a Greek default (and its risks of a domino-effect wave of other sovereign and bank insolvencies) for the coming years, it will have no choice but to print money to bail out Greece and/or its large bank creditors if they’re forced to take material losses on their Greek bond holdings.
In addition, as numerous nations try boosting export growth by cheapening their currency, this simultaneous devaluation of fiat currencies can only boost gold.
In sum, a combination of continued central bank easing with avoidance of a severe, deflationary global recession, would mean rising risk of inflation and eroding purchasing power for the USD and EUR.
2. Ongoing Central Purchases
For the 20 years prior to the Great Financial Crisis (and the loose money policies that followed from the Fed, ECB, Bank of Japan, and others developed world central banks), central banks were net sellers of bullion. Since then, however, central banks and sovereign wealth funds of emerging market nations have become heavy gold buyers, especially on price dips, as they realise the need to diversify their forex reserves out of both the USD and EUR and into more reliable stores of wealth. Growing US budget deficits and debt/GDP ratios in both the US and EZ have shaken confidence in the EUR and USD.
China, Russia, India, Mexico and other emerging export nations are buying in bulk when prices dip. Venezuela has begun to repatriate its physical gold from banks in Europe, the U.S., and Canada. Its motives are unclear, though they may include protecting itself from retaliatory measures from these nations should the renegade state continue nationalizing foreign owned assets in Venezuela.
Meanwhile, the central banks of developed economies, which hold larger proportions of their reserves in gold, have stopped selling as these reserves continue to appreciate.
3. What Bubble? Gold Isn’t Even Close To Historical Highs
Gold’s 1980 high of $850/oz, when adjusted for inflation, is about $2400. So even if conditions today were no worse than those of 1980, it still has over 25% higher than 2011 “historical” highs around $1900/oz.
However it’s not hard to argue that conditions over the coming years are likely to be more favourable for gold than they were in 1980. Unlike back then, today most of the central banks of the largest economies continue to print money and inject liquidity into the markets in a desperate attempt to combat the damage to growth from the debt deleveraging currently taking place in both public and private sectors.
These policy moves are likely to continue and if they do, will undermine confidence in fiat currency and push investors into gold in all but the most dire, deflationary scenarios.
as central banks continue. In addition, as every country seems intent on boosting growth by cheapening their currency to encourage exports, this simultaneous devaluation of fiat currencies can only boost gold
The balance of technical and fundamental evidence is firmly bullish for gold long term. At worst case, it could take from 12-24 months to see a material rise from current prices The only real qualification to that forecast is if we hit a sustained global economic crisis that brings long term flat to negative inflation (aka deflation). That could indeed both boost demand for cash and kill off the chief fundamental reason for holding gold, the need to hedge against loss of purchasing power of fiat money. However, it’s difficult to imagine a really steep drop in gold.
- As the past years have shown, gold can rise in times of low inflation as loose monetary policies keep the fear of inflation alive.
- As long as the largest economies maintain low interest rates and loose monetary policies that threaten to reduce the long term purchasing power of the major currencies, central banks should continue to be gold buyers (and they are big buyers) on dips, making a steep drop in gold unlikely.
WHAT TO DO REGARDING GOLD?
We wouldn’t be adding to gold positions until we’re convinced that gold is back over its 20 week EMA, which has served as its strong support area in recent years. We’d be shorting it only upon a decisive break below its 50 week EMA.
GOLD’S LESSONS FOR OTHER ASSET CLASSES?
Be very careful about applying the implications of your forecast on gold to other asset classes.
For example, as a currency hedge, particularly for the EUR and USD, a bullish bias for gold implies a bearish bias for the EUR and USD, but we would be very cautious about taking action on these currencies based on our gold forecast. There are too many other variables. Rising anxiety about EU sovereign and banking insolvencies could drive holders of Euros into gold, but also into the USD, so it’s possible we could see gold AND the USD rising as the same time.
No other asset is as pure a currency hedge as gold. Silver, oil, and other industrial commodities at times fill this role, especially against the USD. However much of their demand is based on industrial needs rather than currency hedging, so we would not base decisions about these other assets based on their normal correlations with gold.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?