Gold blows up

Gold last night was the vanguard in a wide retreat of undollar risk assets, falling over 5% to settle at $1574USD per ounce before the Asian spot session opens shortly this morning.

As I prefaced in my Trading Day posts this week, on Monday it had appeared the precious metal had formed a reversal head and shoulders pattern, by Tuesday the pattern had been tentatively confirmed by a break in the “neckline”, and I warned before short sellers got too excited:

There is substantial support around $1600 an ounce where a brigade of Zero Hedge buyers stands ready to bid up their bunker inventories of the shiny metal. A break below $1600 however would be extremely bearish and probably alongside a general correction or crash in commodity prices.

By yesterday I became concerned enough to “zoom out” to the weekly chart to filter the noise of daily trading and observed that the long term trend in gold was still intact. However, this has of course changed dramatically overnight, where alongside gold, copper fell 4%, silver fell over 7% and the US Dollar Index rose to almost one year high to 81.2 against all other “undollar” currencies:

And for the commodity complex, this breakout is even clearer as shown by the CRB Commodities weekly chart below, where previous support has been breached and a new target around the pre-QE2 level of 250 (around 15-20% below):

For non-traders, it must be repeated that moves in so-called “risk” or “undollar” assets are defined by the rise and fall in the US dollar. This is a matter of mathematics and faith – when the market contends that everything is good, money leaves short term US dollar assets and flows into risk assets (including shares, Australian dollar and commodities), which is self-sustaining as a lower US dollar helps the world’s biggest economy.

However, when the market is fearful, they seek repratiation to perceived safety and thus risk markets are sold off and the US Dollar Index rises, and the “worthless” US dollar appreciates. This can be clearly seen in this long term chart of the US Dollar Index:

Note how the "waves" in risk on/risk off equate to supply/lack thereof CB support

The chart above can be encapsulated in one quote from Cullen Roche, author of Pragmatic Capitalism, and reminds me of the Q&A session by journalists (coached by fund management prepared questions) of the recent ECB meeting where no QE was forthcoming:

It’s like clockwork. Every time the govt gets out of the way the markets throw a temper tantrum.

Which is why the meme surrounding gold is so interesting. In a recent discussion started on Twitter, Delusional Economics expanded:

Gold is the ‘people’s fiat‘, that is it has no real value however humans intrinsically trust it to have value. So when central banks are devaluing ‘State fiat‘ via “printing”, the people will run to gold as they trust it to store value.

It is actually very odd behavior when you think about it because gold is about as useful as paper to the average Joe. However the fact that it is completely immutable and, thus far, inimitable, seems to have some ‘magic’ effect.

So beyond the magic, what does the technical analysis witchcraft tell us?

As gold has broken its long term moving average (followed by the speculative crowd) and support at $1600, the next target is just below $1500 at approx. $1475USD an ounce, the low of the accumulation point from earlier this year.

The weekly chart is interesting (I’ve included the high/low ranges via candlesticks), because the long term trend since the GFC low has been broken intra-week several times, but buying support has stepped in – on speculation that Central Banks would start up or expand QE programs or ZIRP again.

click to enlarge full size

If we zoom out to the monthly chart, the secular bull market since 2000 is clear, with a clearly intact trend channel, even during the near 30% correction in gold during the GFC. Note that gold has accelerated since the start of 2011 and remains in the upper half of this channel, as it did pre-GFC, so it is setting itself up for a significant correction, probably to the lower edge of the channel around $1300-1400 USD an ounce.

Of course, as Delusion Economics has succintly pointed out, if there is no more ‘State Fiat’ forthcoming, and debt deleveraging accelerates into further writeoffs and contracting supply, the demand for the ‘People’s Fiat” will inevitably fall.

Disclosure: I’m short gold and a lot of other “undollar” assets, via short term and medium term positions, including some hedges. I’m also long the US dollar, including in super where I hedge my undollar positions via an exchanged traded fund, using the Betashare ETF (Code:USD) Please read the MacroBusiness Disclaimer.

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  1. USD sounds good when Au to going down.

    But, use this gift to average in as well IMO. Asia at these prices will be on the prowl before long. This fall could go a lot lower IMO; some serious debt liquidation going on.

  2. I recall in 2008 (about July) that Gold dropped below the 200 DMA – and then played with it a bit while the AUD plummeted.

    That was followed by Gold skyrocketing for a brief period before both gold and the AUD moved back to their trends.

    At one point there was a 90% change – ie if you had bought Gold when gold moved below the 200 (and held against the few small reversals) then rode out the AUD carnage you could have then sold your gold and doubled your money.


  3. My post disappeared, but USD is good now Prince, but this is a gift IMO, and could be used to average in. Look long to see what Asia is doing, and, in general, they are not selling. China via HK gold imports up 200% on 2010.

    Also, remember this is ‘probably’ COMEX contracts, and not much physical. Jim Rogers predicted this a few days back as well.

    • Cullen Roche over at Pragmatic Capitalism has an excellent piece about the breakdown in gold. This quote is priceless:

      “Gold serves like an insurance policy in a portfolio and should never be THE portfolio (I currently hold roughly 5% of my entire holdings in gold). If you’re excessively overweight precious metals in your portfolio you’re making a directional bet on a narrow macro thesis. That’s poor risk management at the very least. Right now gold continues to serve as a fine hedge against uncertainty and a world in which governments are viewed as the cause of the problem and not the solution.”

  4. Thanks Prince. I’ve been waiting for this to happen for over a month now, assuming that liquidation would show up again due to stress among European banks and US hedge funds (?), and that the priced in assumption by investors that ECB and perhaps FED would print would wobble. Even if they will print, and inflation will get worse long term, deflation seems to be in the agenda first, and the markets seem to be thinking about that. That’s how my amateur mind thinks of it anyway.
    Gold is meant to be a good diversification in deflation also, but not so in stagflation.
    I like the bar charts in the link below, although I’d dispute the house prices in stagflation in the situation we are at in Australia.
    Oxford economics discussing gold and other assets in inflation, deflation and stagflation:

    It will be interesting to see how much gold drops. Surely there is a lot of demand waiting to buy in.
    I learned my lesson re volatility of PMs -silver in particular- in September, and have been cautious since.
    What are your thoughts on the USD? Is it still worth buying or is it a bit late now? Many analysts seem to think that it will be one great burst eventually, but does it look like it will have a good run for a while yet?

    • I too no longer trade silver, risk management is not tight enough for me.

      Thanks for the Oxford link, I’ll check it out later.

      USD – in the medium term (through to say March 2012) I think we’ll see it rise to 86-87 points, with the EUR down to 1.20 or so. Beyond that we are looking at a new secular market in USD, which although possible, is likely to be forestalled by the CB’s of the world.

  5. If the bull run in gold is over – and it looks that way – does this portend a fall back to USD250/oz? If so, how long will this take?

    • Surely you jest. Why does it look like the bull run is over?

      What do you believe were the drivers of the bull market and what has changed to suggest that it is now over?

      • I have always thought the gold market was a bubble. Bubbles eventually peak and then deflate. If prices in the economy fall in both absolute and nominal terms, why would anyone want to own gold? You can’t eat it. You can’t make anything with it. It pays no interest and you have to pay to store it. About all you can do with gold is hoard it, which is a form of speculation by another name. And if you do this, you incur the opportunity cost of not being able to do non-speculative things with your money – things that would produce an income.

        • So Gold has been in a bubble for the entirety of the last 11 years? That seems to be what you are suggesting… a bubble suggests an overpriced asset, is $275 what you consider fair value today and how have you come to this conclusion?

          • The property bubble lasted for a lot longer than 13 years. I think the gold market – like the property market – depicts a series of ricochet effects from the whole anarchic credit expansion cycle.

            The credit load in advanced industrial economies has become incredibly large, so large in fact that even with very low or negative interest rates, the real economy is struggling to support the accumulated debt burden.

            In my opinion, this is ultimately related to the role of the USD as the global reserve currency. Long-run stable growth in the non-US world and the corresponding increase in global trade flows has required a plentiful supply of USD. This supply has been met by the ongoing creation of dollar surpluses, at least since the 1960’s.

            Of course, the obverse side of this is that the dollar supply needs to be financed somewhere inside the US economy – in practice, in the balance sheets of households and their proxy, the US Government. This process appears to be on the point of exhausting itself. It is axiomatically almost impossible for the both the US Government and households to achieve a net income balance at the same time, while also maintaining economic stability. However, the US is not far from the point where achieving income balance is going to become a mathematical imperative.

            Like the Europeans, the US is now in a position where it is almost impossible to either grow or shrink their way to fiscal balance. The logical consequence of this is either depression or permanent fiscal instability.

            The result of moves to simultaneously balance the accounts of both the US Government and households will be deep and irrevocable contraction in the US economy. If this occurs, it will catalyse a reversal of the process by which surplus dollars are supplied to the global economy. Dollar shortages will ensue, which will provoke additional contraction in the non-US world.

            In turn, this will induce the collapse of the post-Bretton Woods reserve system as economies seek to combat the deflationary consequences of USD-hoarding.

            For the moment, the unfolding and completely ineluctable collapse of the Euro is driving flight to the USD. But this is not sustainable for long, as USD-appreciation will impel contraction in the already-labouring US-economy. This will only be intensified by the competitive devaluations that will follow the re-basing of European economies in non-Euro currencies.

            The result will be recurrent crisis, contraction, deflation and insolvency. My contention is this is far more likely to lead to the widespread cancellation of debts than to money-printing, not least because in an insolvent world, money-printing will cease to be an effective means of re-booting stricken real-world demand.

            Will gold hit USD275? In a deflationary world, anything is possible.

          • That is certainly a possible outcome briefly, but will such a delationary rolling credit collapse be allowed to play out before Bernanke/Fed steps in again trying to reignite the system?

            It has been my opinion that we are nearing the business end of the bull market in Gold/Silver, I don’t think we are there yet though and think we will see a much larger public run to Gold and Silver before it’s all over.

            If QE3 is launched early next year this could be the final driver in the precious metals bull market pushing them into a true parabolic peak before collapsing with everything else in your deflationary scenario.

            Anyway interesting topic and thanks for coming back to expand rather than leave it at your out of context one liner 🙂

    • My 2c…

      Gold (PMs) are the other side of fiat, really. One generally goes up whilst the other goes down.

      Fiat value is by govt decree, and is therefore dependent on faith in the govt issuer. In this light, if anything, faith in govt decree is decreasing (thus devaluing fiat currency), not increasing.

      As such, PMs function as money – just hard, non-fiat money.

      So, when will the PM “bull market” end? When fiat currency stops devalugin –> people start to believe in the value of govt decree more than they do currently.

      The problem is, though, that it’s only getting worse, not better, for fiat/govt decree.

      We can say that gold has “no function” only if we ignore its primary function – an alternative currency.

      We can say that we can just have “real assets” – property, equities, machinery and the like, and that’s fine – but unless you want to barter, you need a money-medium.

      And since we will not go back to bartering per se, we will use money.

      Hence, it will either be money backed by govt decree, or backed by PMs.

      As I see it from a philosophical (big picture) point of view, it’s as simple as that: where will faith reside for the time being?

      Despite technical and speculative players getting out of PMs for the time being (sell! I will buy more!), faith is, in effect, hoping that the US govt decree is still worth something…but what will it be worth in the medium term, in the ultimately currency of faith? The US govt fiscal position is a job, is it not? We are waiting for the debt load to crunch, are we not? What then of faith in the US govt decree?

      BY implication, I am long PMs for the time being.


  6. For the past 13 years I’ve been reading that gold is a “sell”.
    Gold has since increased 700%.

    • I did say short-term Svetlana. If you sold gold alongside the other risk assets at height of GFC, you wouldn’t complain either. But yes, the secular bull market in gold is still intact.

      Heres an interesting stat from the PragCap article I referenced above:

      “Today, gold dipped below its 200-day moving average (DMA) today for the first time since January 2009. If gold closes below its 200-DMA it will mark the end of the longest ever streak (732 trading days) of consecutive closes above its 200-DMA. Over the course of that streak, gold rallied nearly 125% to its highs earlier this year, and has since declined 16%. Even after the recent decline, though, gold is still up 88% since the last time it closed below its 200-DMA.”

    • And it’s now down 30% in less than 4 months. Gold has been relentlessly talked up by people who own gold and therefore benefit from additional buying interest, in the same way as property developers have encouraged buyers into the real estate market for the last 25 years.

      The compound return to gold is in fact very similar to the compound return on property and the markets exhibit the same characteristics: sensational claims frequently made by self-interested promoters have induced prolonged and exaggerated retail demand, which is now unwinding in the face of economic reality.

      • Interesting that you say down 30% in 4 months.

        US Gold – $1780 4 months ago – now $1581 (-11% change)
        AUD Gold – $1710 4 months ago – now $1591 (-7% change)

        Strange that you use 4 months. Perhaps you could have used 6 months? If you had then you would have $1400 AUD Gold compared to the now $1591, which is an increase.

        You say ‘unwinding in the face of economic reality’ – yet the economic reality is bullish gold. The unfortunate fact is that the paper futures gold market could go to $0 whilst the physical market could go to infinity. I don’t see how you could compare gold to using leveraged paper money to invest in property on the back of an exponential growth in the shadow banking debt money which is now collapsing. That same shadow banking debt which has leverage on leverage on leverage is the exact problem which is driving gold. By looking at the futures market, which is a derivative, to determine the price of physical gold does not tell you what is happening right now.

        TP: I’ve edited your comment slightly macros – just calm down a bit, I think briefly is probably referring to intra-month highs ($1920). Its still a meaningful correction, not quite GFC, but not a dip.

  7. “if there is no more ‘State Fiat’ forthcoming, and debt deleveraging accelerates into further writeoffs and contracting supply, the demand for the ‘People’s Fiat” will inevitably fall.”

    If they go a deflationary route instead of inflationary I can’t see the banks and financial system lasting long, so while such a scenario would probably drive the price of Gold lower in the short term (perhaps this is what you were suggesting) it would still (IMO) lead to a rush by the public into tangible/hard assets as we saw global banking/credit systems failing.

    • People widely misunderstand inflation, in my opinion.

      Inflation only very rarely spins into hyperinflation, and only really occurs when a vast increase in money is occurs in a closed, supply-constrained economy.

      At a practical, day-to-day level, firms can only increase prices when demand is firm and competitors are also increasing prices. It is not possible for producers to increase prices when demand is contracting, which is the likely situation in the coming period.

      The monetarist thesis on inflation is wrong and has been discredited virtually since it first became widely popular.

      Consider the US today, where in spite of the availability of unlimited credit at the bulk level, credit demand at the retail level is falling, and real consumption remains stagnant. The combination of poor income growth, high debts and high unemployment in fact mean that price increases (say for energy, for example) actually impel reductions in consumption and therefore production and latter-round incomes and profits.

      This is the world of debt-deflation. It is the antithesis of an inflationary environment.

      • Hyperinflation is caused by a compouding chain of loss-of-faith events in individuals relating to fiat/govt decree, which spreads throughout a community.

        That is why inflation caused by money-printing may or may not cause inflation.

        Hence, mechanistic descriptions/patterns/etc are no better than correlative, as they miss the real point: shifts in the beliefs/faith of people.

        My 2c

  8. “That same shadow banking debt which has leverage on leverage on leverage is the exact problem which is driving gold.”

    Oh, I agree about that. Seemingly boundless credit has helped sustain the appetite for gold, especially since the end of the Nasdaq bubble and the implementation of a negative interest rate policy by Greenspan.

    But we seem to be approaching the end of the long credit bubble.

    Even if central banks remain willing to supply credit – and, let’s face it, they are more than ready to do this – the real-economy cannot absorb, support and re-pay more debt. The debt market is saturated, like so many other product markets.

    Because debt is not “consumed” like other products of the economic process, but continues to exist and has to be supported and eventually repaid, the accumulation of debt ultimately becomes a barrier to the creation of more debt. We are at that point now and credit markets are ceasing to function – that is, the whole mechanism of credit creation, distribution, sale, purchase and roll-over is decaying.

    This will induce nominal value destruction in the gold market, as in other commodity markets.

    It is unavoidable.

  9. We have seen physical demand from India and Asia drop off quite hard. When gold loses that base support it needs a lot of speculative/leveraged money to keep rising.

    Only when India returns will gold form a base on which it can build.

      • Fair enough. I just saw that 200% increase story via HK the other day and wondered, but China is Hoovering up gold from all over. I have an indirect contact to PBoC and tried to find out what the real flow is, but no surprise there was no answer. The PBoC has increased US T’s so they are not silly, but still will be ready for any monetary gold future should that happen…that’s my opinion anyway.

      • That HK story is delayed news, I’m talking about what we’ve seen in the past few weeks. What we see the bullion banks see, and I’d not be surprised if they see Indian demand drop due to high rupee gold prices they lighten up any proprietary positions and that plus MF Global’s impact on gold futures tips the balance in the market.

        • Thanks Bron. Good to know. I saw the MF Global news and I’m guessing more impact to come on that, and now CME were ‘reported’ to say that they knew what happened and it looked like MF Global were ok, but I can’t see anyone buying that. Maybe tonight there will be more news.

          • With the Indian rupee having tanked over 18% in the last six months(and tipped to go even lower)I do not see demand from India picking up anytime soon.

          • Mind you, if govt action is assiting in decreasing the value of of govt fiat money, and people still need currency, but do not – evidently – value the fiat money as much…where will they turn? Barter?

            I think not….money is too convenient.

            Gold is just an alterative currency.

            Watch for faith events (eg. devaluations of fiat currency, riots, protests, movements, etc…)

  10. Whatever the fundamentals of Gold are, if nothing else I think we’ll see plenty more selling of Gold to cover losses in other markets… that’ll keep it under pressure.

    Since I posted the following chart yesterday evening we’ve seen a huge trend line break, which increases the downside risk. The flipside is of course that if Gold can break back upwards through the trend line in the near term, we’ll have a false break and a raging buy signal. Not high odds in my view but never rule anthing out.

  11. This all depends on whether you believe the US will tolerate a strong dollar index. The major powers are engaged in a beggar thy neighbour policy, in the name of exports and defaulting on debts via inflation – and all will devalue against gold. In fact in this recent post by Mike Shedlock you can see the dollar index yoyoing against other fiat in these currency wars whilst they ALL devalue against gold.

    As Kyle Bass points out there is a very good chance that a hard systemic default will occur, and it’s pretty much mathematically unavoidable if politics and creditors keep kicking the can down the road, but one has to expect more printing/QE by many countries to prevent this deflation from occuring. Not because it’s the right thing to do, but it’s the only logical thing to do according to modern dogma. Moral hazard be damned.

  12. Prince, I’m intrigued that you earmarked 86-87 on the DXY as a “possible target before QE3/ECB”. My intrigue stems from the implication (inferred, admittedly) that ECB QE will have a similar impact on markets as Fed QE. I don’t believe it will. I believe it will see EUR weakness, USD strength and none of the flow through to commodity and ‘undollar’ support that has characterised USD printing. Including, of course, the AUD. ECB printing is likely to see a breakdown in correlation between the AUD and EUR.

    I’d be interested in your thoughts (or better still, a post on likely market outcomes of ECB vs Fed QE).

  13. Very interesting lines of discussion here….a very good example of MB as econo-provocateur.

    One thing does occur to me, and that is in relation to the use of the term “fiat” to describe currencies.

    In my opinion, this is propaganda. In the days of the gold standard, gold was currency by “fiat”, just as the synthetic constructs now called “legal tender” are “fiat.”

    That is to say, the use of this term does more to obscure the nature of economic processes than to illuminate them. Further than this, it is used in part to mount an entirely false thesis about the nature, origins and solutions to our present dilemmas, while also being deployed to encourage people to speculate in gold.

    • briefly,

      Gold has been used as a means of exchange for thousands of years, a gold standard (by government decree) is a altogether different thing then individuals choosing to exchange their labour/goods for gold and then subsequently exchanging that gold for someone else’s labour/goods.

      Gold as means of exchange and store of wealth has thousands of years of form, meanwhile history is littered with failings of paper money.

  14. Everywhere I see i find it hard to go past chaos currently. Taking guide from the most recent history, another easing cannot be ruled out in the near future. Only thing providing a case against it is that inflation isn’t so benign to allow for the helicopter drop to make it more palatable.

    Also with the most recent bout of liquidity by all the CB’s, selling pressure will eventually have to make its way into speculative sphere (the money has got to come from somewhere)

    I don’t have hard stats to back this thesis up, but emerging market domain seems to be driving the market sentiment. Decoupling, NOT, I suppose.