Trading Week: Gold crash equals deflation?

By Chris Becker

Ever since the depths of the Global Financial Crisis, the consensus mood has continued to strengthen around a sole contention that the future must be inflationary; because to rid the world of its massive debt millstone, inflation will be engineered by monetary printing. The corollaryof  this consensus thought is that the only way to offset this inflationary risk is to buy gold.

Yet with the Japanese central bank hell-bent on doubling its monetary base, the US Federal Reserve “flooding” asset markets with cascading piles of freshly printed USD, and similar operations from the European Central Bank and the Chinese with their “mother of all” stimulus packages to keep their grossly imbalanced economy trundling along, where is the inflation?

Why hasn’t gold exploded after its direct correlation with real inflation prior to the GFC? Why isn’t gold priced at $2000 USD per ounce or $3000 Euro per ounce or 13000 yuan per ounce?

(actually gold priced in Yen has exploded, reaching new highs – I’ll come back to that hole in my theory later)

Last night we saw spot gold USD drop nearly 6%, falling through its 2 year support key level:

gold

I study price, not because I believe that price is the be all and end all or like most economic theories that equate it a near-religious meaning. To me it’s just a temporary consensus of a limited number of participants and non-participants and it provides the trigger to my actions as a speculator.  But the price action for gold – seemingly confirmed by the commodity complex – is shouting to me loud and clear: deflation.

Let’s move on…

Remember, the following views are my own, do not constitute advice and are for information purposes only. I may have positions in any or all of the below and their associated markets both long and short, on an intra-day, daily and weekly basis for my own account. Please seek advice from a licensed adviser before making any investment decisions.

Commodities

I’m going to look at commodities first this week. For Australian investors particularly, there’s three major commodities to watch: crude oil, copper and iron ore. I’ll leave the last to Houses and Holes with his excellent daily updates (although it’s non tradeable for retail/private investors – Fortescue Metals (FMG) and Atlas Iron (AGO) are excellent proxies, both of which I trade regularly).

I said last week that price “charts cannot lie about the forces of supply and demand. If everyone is “printing money” and economic growth is strong worldwide, why isn’t their higher oil and copper prices – the two key commodities in the industrialised world?”

This view is summed up in the DJ-UBS Commodity Index, a basket of commodity future prices. Here’s is the longer term view, where a world economy, fueled by Chinese economic growth and Western debt, propelled commodity prices to the moon; crashed during the GFC and re-flated due to emergency monetary responses:

$dubs_us_price_weekly.09nov01_to_10nov13

A closer look at the weekly chart shows the more recent trajectory: if the world is expecting an inflationary future, and real growth has taken over from monetary induced stimulus, why are prices deflating?

$dubs_us_price_weekly.24nov10_to_28may13

Looking at the main components, the only light in this darkness is the WTI Crude marker, which at first glance looks rather bullish with an ascending triangle pattern that is trying to break out to the upside. But each successive high within this pattern is lower than the last:

cl_cm_price_weekly.19may11_to_18may13

ICE Brent Crude – a marker of European demand – paints a markedly different picture, with the weekly chart of the spot price following through on its break below support after bouncing off it previously. The technical target here is the former low in the risk-off move in early 2012 – are we going to repeat it in 2013?

cb_cm_price_weekly.10oct11_to_28aug13

Finally, Dr Copper (so called because its the only “real” economic expert out there) what is your diagnosis?  Using the weekly chart of the London spot price, the pattern has morphed into a symmetrical triangle, but with a definite bearish bias with prices well below the early 2011 highs. Last week saw copper break below the trendline as it caught a cold, but this week it has rallied some (less than 2%).

But is the breakdown in gold a harbinger of more to follow? I contend that a full risk-off situation would be confirmed if it drops below terminal support at 7000:

s1_cm_price_weekly.03jun10_to_06jun13

Currencies and Gold

The US Dollar Index (DXY), made up of a basket of major currency pairs against the USD is a good way of measuring the so-called “risk on/risk off” meme prevalent in asset markets, with a lower USD usually meaning higher risk as US stock markets rise and push other risk assets higher, such as our own share market.

On the weekly chart you can see that in comparison with QE2, where the DXY declined some 12%, QE3 – if measured by USD weakness – has not been successful at all as the currency wars continue.  The DXY is still above resistance at 81.5 points but has been unable to break through the interim pre-QE3 84 point target, also failing to make a new high, which is bearish – and normally be good for “undollar” assets, including gold:

$dxy_us_price_weekly.29apr10_to_14may13

The bearish megaphone pattern that I highlighted previously has succeeded, with the DXY breaking down during the week, possibly retracing all of its strength to 80.5 points. Maybe the monthly QE is having an effect – with rotation to stocks, Yen and Euro:

$dxy_us_price_daily.25jun12_to_15may13

The first general opposite of the DXY is the euro (EUR/USD).   Time to roll out the monthly chart since the euro’s inception, where its been in a decline since the GFC,  for some context:

eurusd_fx_price_monthly.30may01_to_10mar14

After its break of the year plus down trend in August last year, which was followed by a blowoff as it tried to reach 1.37, the euro had retraced and consolidated below resistance at 1.31 with tentative support is forming at around 1.28:

eurusd_fx_price_weekly.20may11_to_21may13

Here’s the shorter term picture with a reversal off the 1.28 key level as I identified previously, and now a break of short term resistance at 1.305, but the daily candles indicate a pause just above this level before trying out for the 1.32 handle. Wait and see mode:

eurusd_fx_price_daily_and_commodity_channel_index___daily___40_periods.16nov12_to_19apr13

The Aussie “battler” (AUDUSD) continues to consolidate its strength on foreign safe harbor buying. The weekly chart is a fascinating picture, giving an insight into how this is playing out. The key takeaway in the medium term is that clear, strong channel between support and resistance at 1.02 and 1.06 respectively since mid 2012:

audusd_fx_price_weekly.03jun10_to_08jun13

The daily chart below shows how after the recent rebound rally from 1.02 to 1.045 was completed, it took a breakout through to 1.05 for the AUD to get going again, but it is hitting resistance overhead, as indicated by the long upper wick on the Thursday candle, and the bearish Friday candle:

audusd_fx_price_daily_and_commodity_channel_index___daily___40_periods.19nov12_to_19apr13

I’ll finish the currency section with the undollar currency of the moment, gold (USD).

Need some context, so here’s the monthly chart back to 1995, encapsulating the last bear market, the 1st phase of the bull market, the GFC correction (a harbinger or what happens to gold when debt is destroyed) and the current “Situation”:

xauusdo_pm_price_monthly.30mar95_to_29aug14

Here’s the weekly chart showing a sideways consolidation, where price kept on bouncing off  a support level at $1560 per ounce. I said last week that the “first deflating (sic) problem calling gold a bubble, is that when bubbles end, they don’t go sideways for 2 years…They go down and they keep going down.” – maybe with this absolutely clear break of support, we’ve seen a new definition or maybe gold isn’t a bubble – its just like any other speculative asset prone to excess and calamity?

xauusdo_pm_price_weekly.19jun09_to_27jun13

I’ve always said that a short term view of gold can provide different opportunities, depending on your bent. Intra-day traders, swing traders looking for 3-5 day reversals, trend and breakout traders and “long-term” investors looking for cheap buying opportunities.  The daily chart gives a medium term and short term bearish view, with a descending triangle with support at $1560 the breakthrough, and also the bottom of a channel with resistance overhead at $1615USD per ounce.

xauusdo_pm_price_daily_and_commodity_channel_index___daily___40_periods.16nov12_to_19apr13

With Friday’s collapsing result through support, the short term picture is pretty clear (although I wouldn’t be surprised to see a rally back up to but not through $1550 in the opening days of next week). Good luck if your “investing” in gold at these levels – because the next stop could be $1300 or even below $1100:

xauusdo_pm_price_monthly.24oct02_to_27may14

Equity Markets

Before I get to the Aussie market, let’s look at the US S&P500 starting with the monthly chart showing a possible end to the US  secular bear market, going on 13 years from the tech bubble high in 2000:

$spx_us_price_monthly.28may99_to_22apr14

Note how the index before the GFC almost broke that high after a blowoff trend (marked in red) that accelerated in 2006 from the main trend. Note also that this pattern has been repeated – albeit with a lot more volatility and acceleration due to continued bouts of QE – with an accelerated uptrend from the August 2011 low. Not the same, but very similar.

The weekly chart below shows this blowoff in greater detail, with a series of higher highs that is smaller on each up cycle. But the market remains on trend from the GFC low and a trend channel of sorts is apparent, with the weekly price basing off the pre-GFC high at 1550 points, although it remains due for a dip:

$spx_us_price_weekly.13aug10_to_26jul13

Looking at the short term point of view, as the US market moves into another earnings season,  this market remains technically bullish, with the 200 day moving average moving smoothly up left to right with a clear trend in place. Support at 1540 points (touched twice in last few weeks) remains key and if the market approaches the trendline at 1570 points in another dip, for the trend to remain intact – i.e buy the dip – this has to be respected. For now, it’s don’t fight the Fed….

$spx_us_price_daily_and_commodity_channel_index___daily___40_periods.09oct12_to_20apr13

I contend that our own share market, the  S&P/ASX200 index  is only halfway through its own secular bear market – mainly on the back of the banking sector, which is completely dependent on an easing cycle in interest rates AND continued increases in national income AND access to wholesale credit markets at cheap prices.

Note these important levels: the key levels at 3800-4000 (strong support), 4400 (intermediate resistance and the outer edge of the index’s real value), 4900-5000 (strong resistance) and 6850 (the former high of the 2003-2007 bubble).

$xjo_ax_price_monthly.30may06_to_17oct13

I have been warning of a possible correction and we’ve had a small dip, with this week reversing those very small falls and only going halfway towards a more sustainable trend that would follow the trajectory of the first uptick in the August 2012 lows, around 4600-4700 points:

$xjo_ax_price_weekly_and_directional_movement_adx___weekly___13_periods.10nov11_to_10may13

On the daily chart, we can see how weakness in the previous week saw the market stay below the psychologically important 5000 point barrier, dipping to 4900 points before a bid in materials stocks this week (BHP/RIO etc):

$xjo_ax_price_daily_and_commodity_channel_index___daily___40_periods.08nov12_to_19apr13

I asked last week, although I got some of the maths wrong, “are we seeing a rotation here from overbought banks to oversold miners? BHP now has a similar yield to CBA believe it or not! Remember, this has been a financial led rally, dependent upon easing by the RBA. If the economy is perceived as being strong enough to not need further rate cuts, this sends a signal to the market, and it is listening. It’s perverse but true. Further, if Chinese markets do not rally soon, any uptick in the mining sector could be short lived.

With the Woodside postponement of Browse signalling the probable end to the mining investment boom, and as I started this week’s analysis, commodity charts signalling deflation – i.e lower prices – this maybe a short-lived rotation.

Here’s the weekly chart of the Shanghai Composite vs the ASX200 Materials sector (red) for context, not the most pretty of charts:

ssec_ix25may06_to_17aug13

That’s all for now, remember to manage your risk first and the returns will come thereafter. See you next week and stay safe.

Comments

  1. ” But the price action for gold… is shouting to me loud and clear: deflation.” Of course it is! We’ve already had the inflation bit, you know, the last 30 years worth of debt creation, and the prices increases we’ve had – the inflation – has already happened and just left us with the debt bit. That’s what’s being repaid now, and why ‘austerity’ has to be the only realistic path to recovery. The debt has to be ‘repaid’ BEFORE we can have any hope of another bout of price inflation. Money Supply inflation; true inflation? Of course! That’s the mechanism to ‘repay’ the debt…and the bill? That’s for you and me to pay…

    • Gold paper market is down because FED is trying to bring interest rates down, if you don’t understand google on “Gibson paradox”, FED wants to force people and banks off gold and to spending and lending again.
      They only sell gold during inactive hours fridays or holidays to achieve max bang for less buck. They work through: google: ESF – Exchange Stability Fund, google: PPT – Plunge protection team – both government organizations established with the purpose to correct asset prices in case they pose danger to the government or economy.

      Also Paul Volcker apparently regrets that government had not been active in gold market after they went off gold standard and dollar collapsed and inflation reached 20% and Gold skyrocketed 800%, they are not going to make same mistake again. So question is whos gonna win? “Dont fight the FED” or “Dont fight the market”

  2. Thanks TP – interesting analysis as usual.

    Whether gold is acting as a precursor to deflation really is the most interesting question at the moment – and i have always wondered whether the easing can outrun deflation given just how much debt was being created in the boom – it might be that it can’t.

    Just pondering a bit more about the financial repression that is going on, whilst it has increased flows into hard assets, i’m starting to wonder whether it belts the middle class much more than the economists want to believe and ultimately will be more deflationary then we currently believe. The middle gets squeezed by expensive loan rates (compared to the big end of town) if they leverage into assets, or they get squeezed by negative returns if they just save money. In as sense the middle are getting a very rough time and have almost no incentive to open their wallets – they have no where to go, the returns they want may come from spending less.

    As for gold as a long term buy – i like Bass’ very simple point that it is simply the only currency they can’t print more of. Traders won’t want to look through the deflation, but those that do might find that an AUD approx 30% over-valued with a breakdown in gold is not a bad thing.

    just mho. cheers.

    • aj. maybe this is a bit off the track but “As for gold as a long term buy” surely land is better, hard to steal, has many more uses, less volatile, less liquidity but you can get a Line of Credit to increase access to funds and no more is being discovered.

      Gold 22.54% devaluation since 06/09/2011 (AUDUSD was trading at similar price closing at 1.0482 on the day)

      • Long term buy if it falls – not long term buy at 1700! But generally i agree with your comments re land. Particularly at the current interest rate settings that are designed to encourage speculation in property – but maybe not with debt.

        My point is just that the current ToT and currency wars may push the AUD higher in the short term meaning gold is not off the table as an AUD hedge and a long term hedge against future inflation. Property is fully exposed to the AUD thats all. Gold at AUD1250 and an AUD overvalued by 30% means gold at 875 AUD.

        I was always of the view that we would have deflation then inflation, and managed to ride the bond yields down on the back of this. Shares and gold have surged, in my view on the back of expectations of inflation and i have (cautiously – probably over cautiously ridden this) – the central banks always had a tightrope to walk to get the balance right. But, it may be that the deflation is baked in – how on earth can Europe, Japan or the US get anywhere without addressing the debt? Even with the current financial repression of negative interest rates it might not be enough.

    • The last 5 years made me save even more, although the prospect of inflation, very much discussed here on the this forum. It is better to have part of something than nothing after spending all of it.

  3. Gold is signaling greater fiscal and monetary stabilisation in US and thus a stronger $US (relatively of course). That is it’s primary driver now and forever.

    • While I agree that a stronger USD has been the principal source of pressure on the gold price, it is worth recognising that the two have been moving in the same direction over the past couple of weeks. I think this says a lot about the bearish psychology pervading the gold market at the moment. This especially apparent last night as weak US data, which typically supports gold and hurts the USD by extending the expected duration of hyper-loose monetary policy, in fact saw a brutal wipe of precious metals.

      ‘Twas a glorious night.

  4. I imagine the gold breakdown has a lot to do with disillusioned bulls. It is rare that you get such a well defined economic experiment repeated in successive years, which is exactly what has occurred with the various QE programs in the US. It was perfectly clear to anyone with a calendar and a chart that QE was driving gold higher. Thus when the latest round of QE was announced, there would have been a large number of buyers assuming this was free money. That in itself is problematic, since those kind of buyers are particularly flighty. But the main problem the bulls encountered was a shift in the way the USD traded. Early this year, there was a decisive shift away from the risk-on/risk-off paradigm towards a more traditional paradigm driven by interest rate outlooks. Traders became more bullish on US prospects, and most importantly, US prospects relative to the rest of the developed world. So this fed a USD rally. Having tried and failed to even breach 1800, gold was in a technically bearish position. USD strength merely piled on the pain for gold.

    The most interesting part of last night’s capitulation in precious metals was that the USD was down also. This was a classic technical breakdown as gold busted through critical multi-year support. Gold tanking in the face of USD weakness is an ugly sign.

    Although I’m not sure that this is a useful portent of deflation. Markets have been so thoroughly molested by well-meaning but hapless planners that they are not of much use for traditional prognostications. One could reasonably argue that equities should not be where they are if deflation is imminent. I think it would take a severe collapse in asset prices that initiates another round of forced deleveraging for deflation to take hold in the US.

    Given that hyper-loose monetary policy is now the norm, I’m not anticipating deflation. Nor am I anticipating high inflation in the near future. The debt burden hangs too heavy around the necks of consumers. Student debt has doubled since 2007 in the US, to $1.1 trillion. Jaw-dropping. Larger debt burdens are being pushed on consumers at ever-earlier stages of their lives. Until the dominant economic ideology informing central bankers and policymakers accepts that consumer debt is not a form of growth (whatever it does to short-term GDP), it is merely foregone consumption in the future, we will remain in this suspended animation, with the next asset bubble always waiting in the wings.

    The longer the stasis persists, the less likely people will be to accept that another emerging bubble is a bubble; they will be much more inclined to regard it as a long-overdue return to healthy growth. Bear that in mind.

  5. Gold increased 500% in value which means it has a lot of inflation built into the price. A drop in the price doesn’t necessarily mean deflation, nor does it mean we won’t get high inflation. It just means that the expectations of long term high inflation are dropping.

    • Exactly right. There’s been a reevaluation of how inflationary QE will actually be. We’ve seen a massive amount of money printing over the last 5 years, yet high inflation has failed to emerge. And that hurt the long gold trade post-QE3. A lot of weak hands expected easy profit while a lot of other participants had become sceptical of the inflation story.

      Whether or not inflation is the eventual outcome is of course irrelevant to the market’s short term direction and a separate discussion entirely.

  6. Any possible connection between falling gold prices and the
    news that European Central Bank president Mario Draghi cleared the way yesterday for Cyprus to sell its 13.9 tonnes of gold reserves to fund the beleaguered island’s bail-out???

  7. I don’t think China is going to experience a lot of ‘deflation’

    Yes it’s property market may fall but that of itself is not deflation.

    I guess I keep thinking who will experience deflation and in what?

    I suspect we’ll get a different answer in different economies. But anyone thinking well we’ll be saved because goods from China are going to be cheaper is in for a really BAD surprise.

    Good post Chris providing lots of thought and room for room for more.

  8. Amazing really how much the topic of gold sends people retreating back into their dogmatism. Just read this by krugman:

    http://www.nytimes.com/2013/04/12/opinion/krugman-lust-for-gold.html?ref=paulkrugman&_r=0

    K implies that people encouraging gold speculation are a special breed of nasties. What about all the spivs that conned people into property and stock speculation before the GFC? What about all the people that were conned into speculating on stocks and property using leverage on an inflated home valuation?

  9. Thanks for the charts Chris. What an amazing week.

    I spent too much time watching twitter this week. Pretty sure I saw news flash by that German CPI and US PPI both printed negative?? In which case deflation is arriving, in everything other than stock prices.

    Previously I have believed that US deflation would strengthen the USD, as everyone scrambles to buy US dollars to pay off their debts.

    BUT what if Europe is the centre for the deflation? as seems likely. Will everybody be scrambling to buy EURos to pay off their debts, driving them higher? And driving the USD lower?

    So many questions… only time will provide the answers.

    Lastly, and I know I’m p*ssing in to the wind, maybe a bull flag on the Gold weekly chart?

    http://www.avidchartist.com/2013/04/gold-bull-flag-on-weekly-chart.html

    • Ah touche Alex.

      Thanks for all the comments, most yet on a Trading Week post – thought no-one reads these, but weekend traffic is building so I must be doing something right.

      cheers

      • Chris, I read your precis each week & find it thought provoking – This week particularly. I appreciate it & Thanks!

  10. It is nonsense to analyse gold as a commodity, central banks consider gold as money. Inflation can show up as deflation, if you choose the right basket of goods to measure price changes.

    If technical analysis has any scientific basis, many more traders would be very rich. Same charts can be interpreted in contradictory ways. Currently, gold is interpreted as a break down of triangle pattern. But if gold price doesn’t fall much more and rallies from here, the pattern is then a bullish continuation pattern called a “flag”.

    If the gold price genuinely reflects the actions of real buyers and sellers, then we may say the price action represents the emotion or sentiment of the market. But the gold price appears to represent unsustainable manipulation of central banks and investment banks, like their manipulation of interest rates (Libor and official rates). Their tools are derivatives (paper gold), fractional reserve bullion market, lending and borrowing physical gold. True derivatives positions are hidden off-balance sheet in the $700 trillion OTC market.

    Major central banks which are all printing enormous amount of currency want to signal the lack of inflation (no loss of purchasing power of their expanding money supply) by suppressing the gold price. On the one hand, they are assuring the market the global economy is fine, the stock markets are near all time or multi-year highs and inflation is under controlled, but on
    the other hand, they are pursuing ultra-loose monetary policies. It is a glaring contradiction, which no one wants to point out.

  11. Marc Faber on Bloomberg TV on the Fall in Gold Prices

    “I love the markets. I love the fact that gold is finally breaking down. That will offer an excellent buying opportunity. I would just like to make one comment. At the moment, a lot of people are knocking gold down. But if we look at the records, we are now down 21% from the September 2011 high. Apple is down 39% from last year’s high. At the same time, the S&P is at about not even up 1% from the peak in October 2007. Over the same period of time, even after today’s correction gold is up 100%. The S&P is up 2% over the March 2000 high. Gold is up 442%. So I am happy we have a sell-off that will lead to a major low. It could be at $1400, it could be today at $1300, but I think that the bull market in gold is not completed.”

    “$1300. Nobody knows for sure but I think the fundamentals for gold are still intact. I would like to make one additional comment. Today we have commodities breaking down including gold. At the same time we have bonds rallying very strongly. If you stand aside and you look at these two events, it would suggest that they are strongly deflationary pressures in the system. If that was the case, I wouldn’t buy stocks or sovereign bonds because the stock market would be hit by disappointing profits if there was a deflationary environment.”

    On gold falling lower if we have a deflationary environment:

    “Yes, I agree. That’s why I said if the gold market collapse is saying something about deflation and at the same time we have this sharp rise in bond prices and the signals are correct that we have deflation, I wouldn’t buy stocks because in a deflationary environment, corporate profits will disappoint very badly.”

    On whether a deflationary environment is possible right now:

    “Everything is possible…In the economy of the cuckoo people that populate central banks, everything is possible. What you have is gigantic bubbles, the NASDAQ in 2000, then the housing bubble and then commodities in 2008 when oil went from $78 to $147 before plunging to $32 within sixth months. That kind of volatility comes from expansionary monetary policies from money-printing.”

    “All I’m saying is that I think we’re going to have a major low in gold in within the next couple of weeks. Gold, as of today, you should actually buy as a trade. I think it can rebound in the next two days by $40.”

    On why gold will rebound $40 in the next two days:

    “Because we are about in gold as oversold and we were essentially during the crash in 1987. From there we have a strong rebound. All I am saying as a trader I would probably enter the market quickly for a rebound of $20 or $40. From a longer term perspective, I would give it some time. We may go lower. I am not worried. I am happy gold is finally coming down, which will provide a very good entry point.”