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Lacking a distinctive catalyst, gold prices have languished in recent weeks after a failed turnaround attempt earlier this month. Golds primary form of price propulsion is fear and uncertainty; as long as investors are worried what the future might hold, gold is treated as a financial safe haven and its price tends to appreciate due to increased demand. When investors arent worried, however, gold is typically ignored and risk assets (viz. equities) become the preferred choice. There was plenty of fear to go around earlier this month: Ebola, the global economy, the U.S. stock market, and a host of other concerns. Now that those fears have abated the equity market has regained its attraction for investors, especially after the plethora of bargains that were offered after the steep decline in stock prices. Gold has once again been relegated to the sidelines and awaits the appearance of the next bout of investor fear and panic. On Wednesday the U.S. Federal Reserve announced the formal ending of quantitative easing, the long-standing policy of purchasing Treasuries and mortgage-backed securities. Gold bugs lamented the end of QE, but the gold market long ago discounted its finale. Actually, QE did gold little favors in the grand scheme of things. Many commodity investors are under the mistaken notion that QE was inflationary, which manifestly wasnt the case. The primary purpose of QE, as economist Scott Grannis has explained, was to satisfy the seemingly insatiable demand for bank reserves and low-risk assets. As Grannis puts it, Without QE, there would have been a critical shortage of safe, risk-free assets, and that would have threatened financial stability. Aside from the observation that QE3 didnt really help the gold price, even if QE had been truly inflationary its doubtful it would have given gold much of a boost anyway. Gold doesnt actually benefit from inflation unless the inflation is extreme. As my mentor Samuel Kress observed, gold tends to benefit most during the hyper-inflationary phase of the economic long wave, or 60-year cycle. Golds biggest booster in the last 14 years came primarily from two things: 1.) the fear and uncertainty of the post-911 world where geo-political turmoil and financial market volatility became regular features, and 2.) the unparalleled demand for commodities from booming Asian economies. China in particular was a big reason behind golds run to stratospheric highs. During the boom years for China's spectacular growth in the 1990s and 2000s, the country accumulated huge amounts of foreign exchange reserves. This led to a significant appreciation of the yuan currency, which as Scott Grannis speculates, was a major reason for higher gold prices. The spectacular growth of the Chinese economy beginning in the mid-1990s created legions of newly prosperous Chinese whose demand for gold pushed gold prices to stratospheric levels, writes Grannis. China's economic boom attracted trillions of foreign investment capital, which China's central bank was forced to purchase in order to avoid a dramatic appreciation of the yuan, and to provide solid collateral backing to the soaring money supply needed to accommodate China's spectacular growth. China's explosive growth and new-found riches were what fueled the rise in gold prices. But in recent years the bloom is off the rose. Chinese economic growth has unquestionably slowed in recent years. China's foreign exchange reserves only increased by 6% in the year ending September 2014, while the yuan is unchanged over the past year. Meanwhile gold prices are down by one-third from their 2011 peak. While Chinas economy is no longer booming, its still growing around 7% a year which is nonetheless impressive. As Grannis puts it, China's economy is not collapsing, it's maturing. Don Luskin of Trend Macrolytics also made a worthwhile observation regarding China's foreign exchange reserves: they are closely connected to the rise in the price of gold. He argues that the outstanding stock of gold grows at about 3 percent per year, but that the demand for gold experienced a dramatic increase in the first decade of the new century as China, India, and other emerging markets experienced enjoyed explosive economic growth. As the demand for gold increased much faster than supply, it was to be expected that the gold price experienced a dramatic increase. As one analyst put it, this amounted to a one-time surge in the demand for the limited supply of gold. Grannis further points out that the growth in China's foreign exchange reserves was exponential for many years, but now it's slowed to a trickle. Capital inflows have slowed, while outflows have increased. The meteoric demand for gold ended three years ago once China's capital inflows settled down to more manageable levels. It also coincided with the regulators decision to increase margin requirements for gold futures positions. Grannis calculates that golds long-term average in real terms over the last 100 years in todays dollars is around $650/oz. Without the insatiable demand of newly rich Asian buyers, therefore, golds price is coming back down to more closely track other commodity prices. In other words, the speculative element of golds price is being replaced by the value element. And until gold reaches a price level which satisfies the worlds value investors, it will probably be a while before the next major long-term bull market kicks off. Rallies in the gold price between now and then are likely to be short-to-intermediate-term affairs and will largely be determined by investor psychology and technical factors (i.e. oversold or overbought market conditions). Sustained demand of the type that fuels sustained longer-term bull markets in gold likely can only occur if either a climate of fear returns (not likely in the foreseeable future) or else inflation rages out of control (again, not likely). So until the longer-term investment climate changes well have to content ourselves with the periodic buying opportunities gold presents to us, taking profits whenever it reaches an oversold condition and awaiting the next rally. Mastering Moving Averages The moving average is one of the most versatile of all trading tools and should be a part of every investors arsenal. The moving average is one of the most versatile of all trading tools and should be a part of every investors arsenal. Far more than a simple trend line, its a dynamic momentum indicator as well as a means of identifying support and resistance across variable time frames. It can also be used in place of an overbought/oversold oscillator when used in relationship to the price of the stock or ETF youre trading in. In my latest book, Mastering Moving Averages, I remove the mystique behind stock and ETF trading and reveal a completely simple and reliable system that allows retail traders to profit from both up and down moves in the market. The trading techniques discussed in the book have been carefully calibrated to match todays fast-moving and sometimes volatile market environment. If youre interested in moving average trading techniques, youll want to read this book. Order today and receive an autographed copy along with a copy of the book, The Best Strategies For Momentum Traders. Your order also includes a FREE 1-month trial subscription to the Momentum Strategies Report newsletter: http://www.clifdroke.com/books/masteringma.html Clif Droke is a recognized authority on moving averages and internal momentum, two valuable tools which have enabled him to call most major stock market turning points from 1997 through the present. He is the editor of the Momentum Strategies Report newsletter, published three times a week since 1997. He has also authored numerous top-selling books, including Mastering Moving Averages. For more information visit www.clifdroke.com
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