long rally has been called into question lately as the Federal Reserve’s talk of possibly unwinding its four-year quantitative easing “experiment” has caused investors to tire of the yellow metal.
In addition to the QE unwinding, other explanations that have been offered include the relation between gold prices and Japanese government bond volatility as well as the general unwinding of dollar shorts as the U.S. shifts from an economy where consumption is funded by debt, to one where consumption is funded by income. We concern ourselves less with the theories behind gold’s decline and focus instead on the metal’s price/volume action.
Chart 1 — Gold weekly chart, 2001-present. The long-term trend is just barely intact.
Chart 1, the weekly chart of the gold index, reveals that this is the first time since the big bull rally in gold began in 2001 that gold has broken below the lows of a consolidation of “basing” pattern as it reaches a critical price point. We’ve drawn a long-term lower trend line on the gold index chart to show that gold is certainly at a crossroads as its long-term trend approaches a potential tipping point. A breach of this trendline could send gold back to major support at around the $1,000 price level.
The question most on investors’ minds is whether such a decline would set up a major buying opportunity for those who still believe that over the longer-term, holders of fiat currencies will move to seek a more reliable alternative. Given gold’s historical and cultural acceptance as money, gold is viewed as an alternative currency. Worries that an unwinding of QE will cause gold’s ultimate demise rely on the erroneous belief that gold’s price move has been driven solely by quantitative easing, which is not the case. Chart 1 shows that gold’s move began in earnest in 2001, long before the Federal Reserve’s creative QE liquidity machine was conceived and put into action in 2009, but well after the Fed’s easy money policy became well-entrenched during the Greenspan era of the late-1990s and early 2000s, leading to the longer-term devaluation of the dollar.
Chart 2 — Gold daily chart, 2001-present. A retest of the April lows may be critical for gold.
Our view is that investors should simply let the current decline in gold run its course, at least until a technical low can be discerned. Chart 2, the daily chart of the gold index, provides one example of a potential bottoming formation as the metal retests its April low, an area that also coincides with gold’s long-term uptrend line as shown in Chart 1. The question is what could trigger a recovery and rally in gold?
Aside from all the other theories that have been offered, we consider the fact that the paper gold market, consisting of futures contracts and exchange traded funds such as the SPDR Gold Trust GLD +1.93% , is about 100 times the physical market. Recent declines in the price of gold have been met by huge surges in demand for physical gold which has proven much more difficult to get ahold of than paper gold which has been figuratively tossed out the window. Thus the paradox of declining paper gold prices versus surging physical demand where steep drops in gold have not led to the wholesale dumping of physical metal. Rather the opposite has occurred. This has resulted in relatively high premiums for physical precious metals, in particular for the “poor man’s gold,” silver.
In pondering this, we have to wonder whether the selling in precious metals is due to the realization that when a currency dislocation occurs, whether in the U.S. dollar, the euro, the yen, or some other currency, paper metals will do you no good — you must have physical. Therefore, the current selling could simply be an unwinding of the paper precious metals trade in anticipation of this. We find some indication of investors looking to alternative, less “printable” currencies, such as Bitcoin and the phenomenon of some U.S. states and municipalities creating their own local currencies. Thus, in such a realm, investors may decide that paper gold is not the solution.
In our view, the Fed is in no position to begin unwinding QE as the U.S. economy remains much weaker than most pundits and government statisticians and number massagers would have you believe, and the Japanese have taken a stance we like to refer to as “Kamikaze QE” as they go all in on the ill-fated delusion that they can suddenly jumpstart their decades long economic stagnation with some sort of steroidal version of what they’ve been doing for about the last 30 years. Meanwhile, Europe remains between a rock and a hard place. This is illustrated when even a small dislocation such as was seen recently in Cyprus, finds no other solutions other than the rote financial engineering and money-printing as bailouts persist as the rule of the day.
Our general view is that a major buying opportunity in gold may be at hand, but because we rely on price/volume action, in other words, market facts, we shun a reliance on theories of all stripes. If gold is able to successfully test its April low and mount a rally from here, then the yellow metal may be able to shine once again.
Gil Morales and Dr. Chris Kacher are both principals and managing directors of MoKa Investors LLC and Virtue of Selfish Investing, LLC, cofounders of www.selfishinvesting.com and co-authors of “Trade Like An O’Neil Disciple: How We Made 18,000% in the Stock Market” (Wiley, August, 2010) and their newest book, “In the Trading Cockpit with the O’Neil Disciples,” (Wiley, December 2012). Both are former internal portfolio managers for William O’Neil + Co., Inc., where Dr. Kacher also served as a senior research analyst and co-authored an in-house proprietary book “The Model Book of Greatest Stock Market Winners”, while Mr. Morales also served as Chief Market Strategist, Vice-President and Manager of the firm’s Institutional Services group, and co-authored with William J. O’Neil a book on short-selling, “How to Make Money Selling Stocks Short” (Wiley, 2004) .