This essay is based on
the Premium Update posted December 18th, 2009
The recent tumble in
the price of gold came as no surprise to experienced technical traders and to
readers of Premium Update. We gave you a heads up to close out your
speculative gold positions before the beginning of the correction. Keep in
mind that even the strongest bull markets need to pause and correct before
moving higher. I’m not even sure that the decline we have seen so far
should be labeled a correction.
Sometimes to see the
future it helps to look at the past. I like history and today I want to take
one item from the history pile, shake off the dust and see what we can learn.
It is an obituary for gold that ran in the Financial Times 12 years ago. The
title couldn’t have been more dramatic - “Death of Gold.”
I read it with
astonishment pondering how in the fast-paced world, economic reality can
change profoundly in a mere blink of the eye.
The article begins by
saying that whereas the Three Wise Men deemed gold to be a gift fit for a
king, a better gift today (meaning 12 years ago when this article was
written) would be US Treasury bonds.
can almost hear some of you laughing. Who today would prefer a U.S. Treasury
bill to gold?
The article goes on to say that “a new
breed of central banker is not dazzled by gold and sees little point in
having an asset that just takes up storage space.”
therefore, in 1997, the year in which this article was written, the
Netherlands sold 300 tons of gold, Australia had reduced its gold reserves by
two-thirds and Argentina had sold its entire gold reserves, all 124 tons, and
invested the proceeds in US Treasury bonds. Two years later the UK dumped
most of its bullion reserves at prices below $300 an ounce.
Contrast that with
today’s scenario. Central Banks around the world are frantically trying
to get way from their U.S. Treasury bonds and purchase gold. After
India’s central bank bought 200 tons of gold from the International
Monetary Fund (IMF) last month, more central banks are joining the stampeded
to step up their gold reserves. Just a few days after the India announcement,
the Central Bank of Sri Lanka announced that it had increased its gold
reserves by an undisclosed amount.
Russia's central bank
has purchased 180 tons of the precious metal on the open market since June
2006 and just recently, media reports from Moscow indicated that
Russia’s state repository will sell 30 tons of gold to Russia’s
central bank. China’s central bank said in April that it had built
up its gold reserves by 454 tons since 2003 to 1,054 tons, making it the
world’s sixth largest holder of the precious metal.
Things are 180 degrees
different than when the article was written 12 years ago.
The Financial Times article concludes with the following paragraph:
“When it comes to
bullion as an investment, and as a measure of national wealth, gold is a
goner. The reverse alchemy is almost complete. Eddie George, governor of the
Bank of England, like Fort Knox, one of the great citadels of gold, recently
told a European parliamentary committee: "Whereas gold used to be seen
as a good asset, it is now seen as the bottom of the pile.”
If you look up the
definition of “sound money” the Wikipedia describes it as
“a globally traded currency that can serve as a reliable and stable
store of value.”
It seems that twelve years after the obituary for gold was written the new
definition for “sound money” should be the kind of money that
makes a metallic sound when you throw it on the table - gold.
Moving on to the
technical side of the market, which allows us to time tops and
bottoms with decent reliability, this week I will provide you with the
analysis of gold and the general stock market (charts courtesy of http://stockcharts.com).
The first thing that
comes to mind after looking at the above chart is that gold is still far from
the 38.2% retracement level of the whole upswing. Taking a closer look
results in one more support level - the $105 level in the GLD ETF. This is
the price that stopped the initial post-$1,000-breakout rally, and it
currently corresponds also to the medium term support line. This may stop the
decline for a while (and both indicators on the above chart: RSI and
Stochastic confirm this), but will it be able to form a major bottom there?
It depends to a large extent on the situation on other markets, but - as
mentioned last week - it currently doesn't appear to be the likely
The analysis of the
short-term situation provides additional confirmations.
The price levels that
were mentioned in the above part of this update are almost perfectly
corresponding to the Fibonacci retracement levels on the short-term chart.
The first (38.2%) level retracement level was just achieved, and the two
following ones (50%, 61.8%) more or less correspond to the abovementioned
$105 and $100 level.
This means that
reaching any of them may cause the price to reverse, but it doesn't seem that
it will be the first level that stops the plunge. Once of the reason that I'm
skeptical about an immediate turnaround is the situation in volume. Please
note that the volume was low on Wednesday, when price of gold moved higher,
and it was high yesterday, when gold declined. This is not a positive signal,
and it suggests that the decline is not over yet. It is currently difficult
to say if it will be $105 or $100 that would stop this plunge, but this
should become clearer once we move closer to these levels - should anything
change significantly I will send out a Market Alert to my Subscribers.
The general stock
market is one of the key drivers behind the prices of PMs, so it is always
usefully to analyze it.
The previous bearish
situation in the main stock indices did not change this week. We've seen the
general stock market rally once again, but the upswing has once again failed
to move above the previous highs, which is another bearish signal. Moreover,
this created a head-and-shoulders pattern, which means that once we move
below $110 in the SPY ETF, the following decline is likely to stop no sooner
than at $107.
implications of this chart are strengthened by the corresponding action in
volume - which is higher during downswings than during upswings.
comes from the analysis of the financial sector.
The situation on the
Broker / Dealer Index creates a bearish divergence with the general stock
market. The financial sector used to lead the whole market in the past, so
the fact that each new top is lower than the previous one, signals that the
whole market may plunge sooner rather than later. This is a negative factor
for the PM market, because precious metals are still positively correlated
with main stock indices. However, this may change in the future, and such
change may mark the end of the current correction in PMs. The other important
market that influences the prices of gold, silver and corresponding equities,
is the USD Index, and this is one of the things covered in the full version
of this commentary.
Summing up, although gold is quite
popular topic in the media these days, vast majority of investors is still
out of the market. They talk about it - become increasingly more interested
in the PM sector - but they are not convinced enough to buy silver and gold.
This is why there is still much room to go for this bull market, and for you
to multiply profits that you have achieved so far (based on this decline only
and today’s closing price - my Subscribers saved 11% (no leverage) of the invested capital on
selling GDX near the top).
From the short-term
perspective, however, it
seems that the correction is not over yet, and that its
second part has just begun. This outcome has been indicated by several
markets, so its reliability is rather high. Additional details including
targets for USD Index, SLV and GDX are available in the full version of this
essay, along with 18 detailed charts with implications on your portfolio.
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Thank you for reading
and have a great and profitable weekend!
by Przemyslaw Radomski