Gold looks vulnerable

I am of the view that the bull market in gold is far from over. To me, it’s obvious that so long as the fiscal and monetary frameworks that support the $US are in chaos, then gold fundamentals are strong. Arguments over the value of the metal are irrelevant. You can’t price chaos.

This is the point missed by that those who describe the gold price as a bubble. It will no doubt become a bubble at some point, when those fundamentals weaken, and the price continues to rise only because it has already risen. But so far there is no sign of stabilisation in the fiscal and monetary frameworks that support the $US.

That is not to say that gold will not drop precipitously at some points within the larger uptrend. When the $US rallies during large risk-off events, gold will likely correct, perhaps significantly. The 30% selloff following the Lehman Brothers collapse in 2008 is a case in point.

We may be approaching another of those points. As Delusional Economics has so studiously documented, Europe is beginning to fragment. According to Deus Forex Machina that has finally knocked the stuffing out of the euro and it is set to fall, probably substantially. As I have explained before, when the euro falls the entire reflation dynamic of the world economy get’s wiped. That’s because, coming out of the the great global imbalances of the Bretton Woods II era, the US can only grow through stimulating external demand. It does this by weakening its currency. But with a falling euro, there is always a corresponding rise in the $US. And we are seeing that now. From Bespoke overnight:

Moreover, the weakness in Europe that is causing the macroeconomic shift from the euro to the $US is exacerbated by the $US funding needs of the European banks. We have known for some weeks that European banks have been struggling to raise $US funding as US-based money markets froze them out. Now from the FT comes the following:

European banks are facing increasing strains on their balance sheets because of the dramatic jump in the cost to borrow dollars, essential for some institutions as they need to repay loans in US currency.

The cost for European banks to swap euros into dollars has jumped fivefold since June, hitting the highest levels since December 2008, and raising the risk of insolvency in the region’s financial sector.

Strategists estimate European banks face a $500bn dollar funding gap – the sum they need to repay loans and obligations in the US currency over the coming months. The extra cost to swap euros into dollars, therefore, could make the difference between survival and bankruptcy for some institutions, strategists warn.

So, there’s a develpoing need for $USs, which is a parallel with the credit squeeze of 2008,  even if it so far remains well below those panic levels. As Delusional Economics points out this morning, these tensions are only likely to increase as French banks face downgrade action from Moody’s.

So, with this setting of a developing run to the $US, I asked The Prince to take a look at the gold charts. Here is his take:

Technically, the current medium term uptrend in gold began in October 2008, as this weekly price chart below shows:

Corrections since then have averaged 8-10%, but have reduced in magnitude from the end of each subsequent round of Fed QE programs. Some were purely reversion to the mean corrections (marked as KC Signals or “too fast”) as traders pushed the price of gold back to its trendline:

Using an oversold/overbought indicator below the main chart and a trend channel, these overbought or too fast rallies are clearly evident, whilst the current price action most resembles the blowoff in November 2009:

A reversion to the lower end of this price channel implies a correction to approx. $1600-1650 USD per ounce over the next 2-3 months. The short term price action is a double top formation, with a closing break below $1800 an ounce indicating the start of a correction.


So, gold looks vulnerable on the back of a run to the $US. Does that spell the end of the bull market? You can expect the usual suspects to pile in and tell you so, even though they’ve been wrong for a decade. But no, it won’t be over. What will follow, or accompany, the fragmentation of Europe will be QE3 (4,5,6 etc). At the same time, if QE3 were to come sooner rather than later it would threaten this forecast.

Anyway, whenever it does come, gold will resume its climb. How high? As high as the monetary and fiscal chaos is long. Much higher, I suspect, than we see it today.

Houses and Holes
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  1. Exactly. Lots of money looking for a safe place to go, and what’s safe now? CHY gone for now, but the Swiss had to act. Last week Merk took USD90M out of US T’s into the AUD, so we might be the next country to sustain a currency attack (more than the current level). I’ve seen estimates of AUD at 2.0. I expect a crash before that happens, but ???

    The central banks publicly discount gold, but still use it, and a growing number are buying again. It’s risk off now and unless we get monetary stability gold will continue to rise. The China Wiki story is a good indicator of where gold is going IMO.

  2. For those holding unhedged USD gold then how the big risk-off will treat the Aussie dollar is a factor and possibly the bigger variable. I know DFM thinks the AUD has been re-rated, i’m not convinced but i guess we me yet see.

      • Also interestingly the last few nights gold has tried a few time to get to 1900USD only to be smashed back down. Maybe i’ve been reading too much z.hedge but this all smells a bit fishy…

    • Anyone holding gold and not hedging the AUD/USD is taking two bets: USD gold and AUD/USD.

      AUD gold = USD gold divided by AUD/USD exchange rate.

      I know which of the two bets I’m most comfortable with.

      • yes and no? Gold might be priced in USD but it’s not tied to USD (ie a devaluing USD just sends USD gold higher)- wouldn’t the bet be AUD vs Gold still (ie AUD smashed in GFCmkII)? Or am i making the mistake of treating Gold as a currency (a little to prematurely)

        (genuine question btw)

        • Gold is priced in USD.

          Its price in any other currency is a function of the USD price and the exchange rate between that other currency and USD.

          These are mathematical facts. Arbitrage ensures that they hold true.

          It’s called the “law of one price”.

          You are right that the USD price of gold is not “tied” to the USD. Although usually a falling USD will lead to a higher USD price for gold, that is not a given.

          Whenever you hear someone say the “price” of gold is rising or falling, you need to ask: in terms of which currency?

          Note that gold mining stocks are a different beast. For example, Australian gold stocks are more likely to follow a big US gold stock index (like HUI) even if AUD gold is heading in a different direction from USD gold.

  3. Enjoyable post.

    The Prince, I would be interested in your take on a technical upside target if that uptrend line from July holds and we see an ascending triangle form and breakout to the upside (rather than to the downside).

    After we saw Gold breakout from the channel it had been trading in for 3 years:

    I have been concentrating rather on the undervalued Gold stocks, which have been trading at lows (as ratio against spot price) not seen since early 2009 and they have just broken out to new nominal highs (GDX/HUI).

    Seems I am not alone with high expectations for Gold stocks with ZH pointing out this report from Morgan Stanley:

    • BB – you are correct in pointing out another possibility – and this would suggest a run up to $2050 per ounce by October or so.

      It would not surprise me, technically, to see a new medium term trend line “angle” with gold at a much higher pitch.

      On a semi log chart, the initial gold bull market from 2002 to 2006 then accelerated through to the correction in 2008 and is now at a higher momentum reading (use 12 month TMO)

      I concur with your Pascoe posts – we are still a long way from a technical bubble and a correction would actually reinforce that view – because if gold corrects meaningfully, it means that the participants required in a bubble (i.e the public) are not yet in the market.

  4. I agree re: some sort of correction – was initially saying $1650 (gut feel!), but I’m surprised it hasn’t already happened. From observing dailies, there does seem to be a LOT of people buying dips, when they come (and they are quite frequent, even on dailies!).

    Also – and I think this is an important point – I know some gold bulls that are even calling for a 30% drop in a risk-off event. I must say that I am becoming less and less sure that such an event will occur, and this is the reason: I think gold is actually becoming more and more risk-off itself, even much more than it was during the GFC.

    ie. global sentiment towards gold’s role in the international economy has changed – it is now more an alterative currency than it was just 3 years ago.

    I agree that many will sell in a serious risk-off event (run to USD); but I also think there will be proportionally more people buying that dip, such that we would only be looking at a 10-15% drop tops, rather than a 30% monstering (eg. I will be buying more if gold and silver geet hammered even 10%)

    ….I just sense that the the attitudes of many towards gold have changed substantially since the GFC, such that it will be treated quite differently in the next major risk-off event.

    My 2c

    • I agree BurbWatcher, I suspect the days of monster corrections in the Gold bull market could be behind us. There has definitely been a shift in attitude toward Gold since 2008.

    • I wonder if there is going to be even less faith in the ‘system’ this time around and this may spill over into fiat currencies and possibly gold as reinvigorated global currency.

      In GFCmkI many of the large finance houses were shown to be rotten to the core. Since then we have watched the ECB have no problem telling half-truths, and governments/reserve banks genuinely struggle with currency valuations and what an appropriate response is to bankrupt banking sector.

    • I agree. There is buying going on, but how do you see OTC buying? Gold is being shipped to the LBMA, and ETF’s are one big buyer, but others that are not disclosed also. You get a lagging view from the WGC, but I’d be gobsmacked if that was all there is.

      I don’t know all the answers, but it’s hard to find a more opaque financial asset than gold IMO.

      Also, look at the CME resisted depository and it’s down 3.5M oz since 2007, and while some of that is from reduced production, there is physical delivery draining it faster since the GFC.

      IMO don’t discount political intervention in this asset class if things get messy.

  5. Waiting for deGaulle.

    Faced with crisis, the man of character falls back on himself. He imposes his own stamp of action, takes responsibility for it, makes it his own.
    Charles de Gaulle

    • GG, the quoted research is exactly why Soros got out of ETF’s the story goes.

      I’m not sure of the complete validity of this, but with fractional bullion ratios like 100:1 if all the COMEX trades demanded physical there would be a squeeze probably. Some of these COMEX trades might just as well be on grains as there are times when the return is better than gold, and they end in a cash settlement.

      Physical gold moves, but the web of movement is not in a straight line, and you have to be careful of that in analysis has been my findings.

      I believe there is manipulation in gold, but I don’t know the truth of any of the assertions, and I don’t trust GATA not to give us a continual flow of conspiracy theories. As always let’s see the real evidence. Rob McEwen says it’s the governments mandate to manipulate gold for currency stability, but like all these instruments it’s flaky and non transparent so it’s hard to know what’s really going on IMO.

      “Doug Hornig of Casey Research recently researched GLD by scrutinizing its prospectus and interviewing its sponsor. He concluded that ownership in it, even among investors holding more than 100,000 shares pre-approved for share/gold conversion, does not practically constitute gold ownership for shareholders. Were there to be a sudden run on physical gold that would close gold futures trading, GLD’s sponsor would not be able to open the shares for trading. All credits and debits would be reconciled in dollars.”

  6. I sure wish there was a huge correction in gold and silver, because that would be an opportunity to really load up.

  7. Gold is down to $1831 just before the London session (where it cracked down on Friday).

    If it closes below $1820 or so tonight after the US session, the correction will be well underway, with target at $1650.

    • Really depends on whether there is bad news, eh?

      Gold seems to drift downwards when “not enough” bad news is getting reported.

      …wait up, now there’s a way to manipulate the price! manipulate the news!

  8. Adrian: Please see FOFOA “Who is draining GLD” for the best
    analysis of how a minimum 50,000 0z can be redeemed trough
    one of the 17 qualified sponsors.

    • Hi Robert, thanks for the link. I’ve seen the allegation from a different site, and it’s possible reading the ETF’s fine print.

      I’m not sure Eric Sprott would be happy however, but if you go to the Symposium in Sydney you could ask him as he’s there this week; I was going, but had to pull out. He’s a bit suspect IMO as he’s alleged there was a silver squeeze and that’s been shown, by a few traders, to be incorrect. Again, vested interests have their version of the truth. Sorry, but I’ve read so many incorrect stories in my research.

  9. Gold getting smashed WHILST USD rallies last 6 hours.

    Gold hit a historical high against the Euro of just over E1370 a few hours ago and whammo now Gold is getting hammered as EURUSD rallies.

    Free markets? Where is there a free market?

  10. Re: silver squeeze, the future of siver prices, etc. I don’t fish in
    those waters for one reason: until a world central bank decides
    to hold silver as reserves (the last was China in 1935) the price
    will be determined by factors I can’t analyze. With gold on the
    road to becoming a global CB reserve asset which FLOATS in price, and is therefore de-linked to any currency at a fixed rate,
    (AKA Freegold) that is all I wish to hold – as physical, not a cash
    settled contract.