Bearing the bull on gold

Coming out of the new year, alongside other risk assets, gold has seemingly reversed its recent falls, climbing above $1620 as risk managers and robotic algo’s bid up risk on sentiment expectations from consensus building and reaction to continued positive dataflow from the US economy as 2012 gets underway.

As always, the sentiment behind gold’s rise is two fold: from both the perma-bulls (risk to the moon! interest rates are zero! everything is cheap!) and the perma-bears (buy ammo! USD going to zero!).

The real question is, has the fall from $1900 to $1560 created yet another temporary bottom in the price of gold on its inexorable rise to $1850-$2000USD per ounce as forecast by both Goldman Sachs and the Australian Government , or even higher to $5000 or $10000 as governments (adopt your best German/Austrian accent here) “print print and print”?

Predictions are hard to make, especially about the future, so this we have to consider the probabilities of either:

  • a continued secular bull market that started in 2000 (consensus)
  • a sideways trading range (with mean reversion to trend, therefore consensus)
  • a continued correction before getting back on track (overshoot then reversion as above)
  • a new secular bear market (contrarian)

Here’s a chart that has been displayed many times before, but captures the psychological behaviour behind “the madness of crowds”:

Does this study match the current technical chart of gold? Heres the weekly chart since the start of the secular bull market way back in 2000:

click to enlarge full size

It certainly seems to match up quite well with the “phased bubble” sequence we’ve covered here before on MacroBusiness. The recent correction – just shy of the typical 20% number used to characterise a bear market in any asset, also fits the “bull trap” meme.

The “return to normal” and capitulation phase is is a very complex and debatable subject, usually hinged on the notion that lower interest rates are fuelling inflation and therefore gold must rise until ZIRP (admitted by the Fed to last at since until 2013) is reversed.

Unfortunately, this thesis conveniently forgets that outstanding private (and some sovereign) debt and equity (mainly house prices, but also stocks) are being destroyed by deleveraging and outright default.

One of the world’s most successful hedge fund managers, George Soros, has recently sold almost all of his funds shares in a gold ETF, calling it the “ultimate asset bubble”, but ever flexible, noted that buying at the start of the bubble was always a rational idea.

The consensus from the mainstream analysts and fund managers is the contention that the shiny metal is merely overbought and undergoing an orderly correction before resuming its upward trend – a “return to normal”.

Luckily, the technical charts are quite clear on gold, making it a relatively easy risk asset for trading or investment purposes, particularly if you’ve been long for the last 11 years!

The weekly chart above shows that gold has clearly deviated away from the simple 3 year trend line since the GFC. This is providing ammunition for the sideways trading range/continued correction that deviates slightly from the consensus “gold to the moon”.

But the monthly chart above confirms (for now) the consensus thesis: gold remains in a secular bull market, albeit going sideways, but moreover is in the middle of its trend channel.

This implies that the bull market in gold can still continue, as it did post-GFC, even if the price falls to ca. $1400-1500USD an ounce.

For those who discount the “phase” theory of bubbles, and/or that the return to mean implies continued USD currency depreciation into the decade, such a fall would offer a great opportunity.

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  1. On your linear chart, it does look like gold’s price has steepened, had a bubble spike, is moving down.

    On your log chart, the price of gold appears to track up in a straight line. No phase transition or blow off yet.

    Not being a technical analyst (although I try to follow others), I don’t know which type of graph is more relevant for determining this phase transition.

    In terms of a blowoff in gold, I’ve listened to a Felix Zulauf interview where he quotes the concentration of global financial assets allocated to precious metals as less than 1%.

    In 1979-80, from what I’ve read it’s alleged this was concentration was between 10-15%. If that concentration level is a guide, it would tend to align with your log chart of gold. ie no blow off top yet.

    Another interesting comparison is Gold price vs US Debt Limit.

    Given the unfunded liabilities in many countries (US/Europe/Japan), I would expect the debts of these countries to keep increasing until some sort of crisis point/ resolution point occurs.

  2. A more detailed log trendline here has a potential bottom at circa $1300 will the trend still intact.

    I feel we will be looking at a 2008 style correction which will take us down to $1300 over the next 6-9 months.

    As to the bubble phases, we are still in awareness – there is no mass market/public appreciation of gold’s 11 yoy increases nor (certainly in Aust) widespread disillusionment with conventional investment classes, at least not enough to have average investors even consider gold as an option to preserve wealth.

    For Aussie investors if we get a continued correction in USD gold prices with a FX rate above 1.0, then it will present probably the last great buying opportunity.

    • nice chart Bron.

      I try to keep my posted charts on MB simple – my own charts for trading are slightly more detailed, but even still I’ve cut down on a lot in recent times, even the way I draw trendlines is just with a wide line.

  3. Prince, the trick with gold (and I’m pretty sure you disagree with this point), is that it is being priced with currency as the denomination. The problem is that from a historical stand-point gold is the denominator. You use gold as the unit of account. Fiat currency is not a useful long term store of value (as it eventually dies) and therefore does not do the good well over long periods of time.

    I know is sounds like ‘its different this time’, but it is a case of fiat currency being in a bubble and not gold. The biggest thing I can say against that is that saying that fiat currencies will last forever because ‘its different this time’ is actually the biggest problem. Gold has been around since our existence. Fiat currencies come and go – that is the problem.

    We have monetary problems which appear unsolvable because it requires a grand default or wipe-out from devaluation. We are going through a managed devaluation path and this cannot help but be reflected in the amount of that currency to be used to purchase an ounce of gold. Gold is just acting like a mirror in the case and is NOT a financial asset in the traditional way of thinking in modern markets.

    Interestingly enough this just popped up which shows gold since 1265 in British Pound terms:

    You could say that recent times have been the aberration and that we may have a long time where gold is valued highly relative to other things due to the uncertainty in financial markets and in particular the currency markets.

    • I almost included the ZH graph – it came up on Twitter as I was publishing the post.

      I actually agree with you Macros, except that gold also “comes and goes”, like fiat/credit based currencies, throughout history. There has not been a gold (or silver) standard from wo to go throughout recorded history. It was spots of gold/credit/nil/silver/fiat/gold/fiat/silver etc, depending on time, place, culture, with overriding/dominant reserve currencies (USD, GBP, Dutch gilder, Roman denari…..Chinese Yuan?)

      This is somewhat evident in that ZH graph, but a more rounded reading of history shows empirically that a precious metal is not the ONLY definable monetary (when there was anything representing money……key point..) standard.

      I’ve also said numerous times here that physical gold is not a financial asset, whereas gold traded on an exchange is….just like any other commodity, currency, equity or debt instrument.

      As for bear or bull, I am neither, as again I think the terms are absolutely meaningless without a time context. In the very short term (i.e this month and next), I’m bullish gold. Throughout 2012 and past 2013 I’m bearish/flat until I see a change in macro conditions, particularly what happens with end of zero interest rates.

      Longer term (5-10 years plus) I just don’t know. Nobody does. We could have a return to a gold standard, and therefore a deflationary monetary era (as a return would most likely require the solution that will most likely NOT be done – jubilee), or somehow, we could progress to a new reserve currency as US dominance wanes (which may or may not happen), maybe Yuan and we start up the fiat currency cycle again???

      • Well said.

        I’m bullish but only because of what is currently happening. However I’m not a perma-bull and am happy to change my view. The types of scenarios you mention are all possible – the future is not written in stone.

      • >I’m bullish but only because of what is currently happening.

        And there it is – as opposed to the delusional thinking of perma-bulls and perma-bears.

        Here’s the latest, which is frankly frightening (although Macros may agree with the bond selloff idea….?):

        Scoreboard by Adam Carr

        • I’m very negative on bonds because I cannot see deflation.

          But how/when will it play through?

          One thing that I do know is that I’m frightened to agree with Adam Carr on anything.

          Government bonds can stay at low rates for some time if there is sufficient willingness for CBs to support them. But if they are flat then equities become much more attractive.

          My understanding is that huge fund flows have gone in to bonds globally (govt & corporate).

          I do know that there will be further stimulus this year to ensure there is sufficient funds to buy govt debt.

          I’ve turned very bullish on equities, and can see the potential for funds to flow out of bonds and through to equities once again. If this becomes a trend, then it could be the catalyst for bond prices to fall.

          I’m not willing to suggest when these factors could impact on bonds – because I don’t have sufficient information to make that call.

      • “It was spots of gold/credit/nil/silver/fiat/gold/fiat/silver etc, depending on time, place, culture”

        According to David Graeber in his book “Debt: the First Five Thousand Years” it has always been credit (with gold/silver/fiat taking a backseat).

        • That’s not exactly how I read it cyrusp – although semantically you could replace the word “credit” with money – there are both the same when it all boils down to it. (and both unreal….)

          For those who haven’t read the book or associated empirical literature:

          First, there’s almost zero evidence of a barter based system (except in small cross trades between diverse tribes/cultures at extremes) , so that’s off the table.
          Second, in pre-financialised communities and civilizations credit was mainly used, but then is dominated by commodity based currencies mandated by the State, and fleshing this out across mililenia and eras, this has switched back and forth, with different types of commodity standards (silver used more often that not, but gold usually) as States required.

          (e.g there is more than one type of gold standard….and the one used last was actually more FRB credit based than anything else on the private side, whereas sovereign money was indeed gold restricted).

      • Prince, your statement “physical gold is not a financial asset” … are you sure? Even Ben says it is … while he will not concede it’s money. Maybe this is out of context.

        Some points to note ..

        – institutions are not selling physical gold nor are individuals in general.
        – the gold price is set based mainly on futures contracts, and the CME has done much to change that in 2011.
        – gold is used by CB’s as a reserve … they don’t generally use paper gold other than to manage the gold price.
        – just look to Europe and the scramble for Tier 1 debt … well it’s not there so even unsecured debt is ok. If you accept that then we’re in a very dangerous phase IMO.

        I’m neither a bull or bear, and look to history to see the likely outcomes, but at the end of the day the politicians will control what happens to gold as they have done in the past so any predictions are worthless IMO.

  4. Here’s another model I’ve just cooked up. I call it the Theory Model. Think of four groups of investors looking at gold in different ways:

    1. Gold bears and skeptics ( Pascoe types)

    2. Those who see it as a hedge or store of wealth, as more fiat currency kicks around the system.

    3. Investors who predict an inevitable ‘basket’ of reserve commodities/currencies, including gold, to take over the USD.

    4. Austrians/inflationists, wanting and predicting gold-backed money (Peter Schiff, Ron Paul, Marc Faber maybe?)

    As the proportion of investors tends towards three and four, the price goes up. Predict what feeds each of these memes and you’ll predict the price, keeping in mind that memes don’t have to make sense what so ever eg. QE causing inflation.

    • Agree 100% with those camps.

      However I think the ultimate driver will be central banks and whether gold will be used as a reference point for currency. This is not impacted by investor camps bullish/bearishness.

      Unless we are able to find some real economic growth from somewhere, it is a real possibility as it would be required in order to create confidence once the debt levels have been sufficiently eroded.

      • ‘However I think the ultimate driver will be central banks and whether gold will be used as a reference point for currency. This is not impacted by investor camps bullish/bearishness.’

        But investors are the ones determining the price. People will speculate on this and more will flock in to groups three and four BEFORE this epic event takes place (if it does). One could argue that’s been happening in the past ten years already.
        Sure, there could be a surprise synchronous announcement about gold-backed currency from some major reserve banks , but you’d be looking at Armageddon conditions, a massive ascendency of Austrian economics, and a lot more people would be talking like you (and driving the price up). Incidentally I don’t think that will ever happen unless Ron Paul becomes president.

        My point is, bear and bull thoughts aside, gold more than any other asset is driven by conflicting stories. It’s actual physical demand and supply seems inconsequential. Even more so than Australian housing ;)……

        • “My point is, bear and bull thoughts aside, gold more than any other asset is driven by conflicting stories. It’s actual physical demand and supply seems inconsequential. Even more so than Australian housing”

          Agree with that thought. Was just mentioning that a one-off adjustment could be possible at some stage to back a new reserve currency and the price of which could be determined by CBs and not the markets (would not have to be Armageddon).

    • Could there be 5 as well?
      Those who see it as a store of wealth and believe in a long term uptrend BUT with a significant short-medium term downside risk and therefore sit on the sidelines at times?
      Group 5 might be in and out contributing to volatility.

  5. Prince, where do you stand on the paper gold vs physical gold debate?

    The physical holders assert that paper gold (EFTs etc) is a ponzi scheme and at some point we’ll see a huge divergence in the prices of paper and physical gold.

    • To quote Prince from above:
      “I’ve also said numerous times here that physical gold is not a financial asset, whereas gold traded on an exchange is….just like any other commodity, currency, equity or debt instrument.”

        • no disrespect intended to the Prince, but what does it matter what he thinks? I mean if you make an investment choice based on what he thinks (or even influenced by it) do you think he’ll offer you any sort of warranty?

          perhaps I’m just missing what basis you’re asking his view on this?

  6. Cyrsup
    I do understand your question however I would add this from a purely practical viewpoint.
    A little while back I held both paper and physical Gold.
    One day I got it through my head that I had better investment options and sold the paper gold and bought some equities. Short term it was a very bad decision but the thing is starting to sort itself out.
    So paper has pluses and minuses. It’s easy to trade which may be bad or good!

    The physical is still safe and sound in my possession.
    So in agreement with macros there…paper gold is a financial asset.
    The physical gold is well….gold.

    • “One day I got it through my head that I had better investment options and sold the paper gold and bought some equities.”

      Whilst I think of ETFs as paper, I view equity ownership of real businesses with real productive assets to be effectively non-paper assets. I would put them along side owning physical allocated gold in a bullion bank that you are paying a fee for storage. You have a real asset, but still have counter-party risk in the trustee as you do not have the physical asset in your possession.

      • Agree macros…that was part of my reasoning,

        I do wonder about the ASX GOLD I forget the new symbol for now. It is supposed to be backed by actual gold at the Perth mint.
        May be a bit different to some other ETF’s. Mind you, as everyone says, you are reliant on the thought that no one is lying anywhere. In the modern world the old sense of honour doesn’t seem to apply.

  7. I must add that the great divergence has been predicted for years. Of course it hasn’t happened …yet!

  8. celestialspring

    Can someone compare this to total revolving credit and M1 and M2 all over the world. I am sure if that is compared to gold ‘price’ it would be still undervalued by a great deal.