Commodity Outlook: Gold Trends & Market Forces

Last Updated: Wednesday, August 29, 2012 - 19:41

Shamik Bhose

Gold is nearing a crucial level on 'The brink' is one of those phrases that keeps getting bandied about by all.....I'm never quite sure what it means. Greece is on the brink, they tell us. Europe is on the brink. In fact, since the global financial crisis began back in the halcyon days of 2007, rather a lot of companies and countries have been 'on the brink'. Iceland even went over it. But do you know what? After Iceland went over said brink, life carried on.

I rather wish all those other countries; governments and institutions with un-payable debts would just get on with it and go over the brink. Then we could purge, move on and get this financial crisis over with. All these policies and loans and bail-out funds to pull whoever or whatever back from the brink do, is to delay the inevitable. Meanwhile, innocent bystanders get caught in the crossfire of volatility. And the rest of us feel like we're waiting in some kind of losses pending tray.

Gold, however, was this week on the brink. On the brink of what? Well, on the brink of... going lower. I have drawn a red line on the chart below at $1,525 an ounce. That red line is your brink. Gold has tested that line three times now. It has so far proved support. I see it as a big, big level. And I really hope it holds.

Gold is in a downtrend now. It's been in a downtrend since last September. It edged lower in March and April, but that downtrend suddenly accelerated in May and now the moving averages are all sloping down. I'm hoping this week was the final capitulation, but I can't be sure.

Why the $1,525 level matters

We have to accept something. And that is that during the early stages of a financial panic, despite the fact that you might intuitively expect gold to perform well, it doesn't. 2008 proved that. And now we see it again. Government bonds are – for now – the perceived safe haven. I have no idea how long this will last. Given that most governments are wallowing in un - payable debt, it seems odd that their issuance should be a safe haven, but that is where institutions and fund managers and investors park their money – not gold. How ironic that government bonds should be called 'gilts'.

Coming back to that $1,525 level in gold... Why am I so keen for it to hold? This next chart shows gold since 2000. The blue line is the 252-day moving average. There are around 252 trading days in a year, so effectively that blue line is the average price for the past year. Since 2001, gold has only gone through that blue line and stayed there for a significant period of time once. That was in 2008.The problem is, these last few weeks it's done it again. It's sunk beneath.

I don't know about you, but I don't fancy another 2008..That's why I'm so keen for that red line to hold. If it doesn't I expect the next stop on the way down to be just above $1,400. After that we're looking at the $1,250 area, where, even in the worst-case scenario, I would hope for us to find a bottom. You can see why I am so keen for this $1,525 area to hold. While it does so, my theory – that gold is in consolidation mode after its run up to $1,920 last September – still holds.

If it doesn't, I think we're looking at something more serious – a meltdown of asset prices, not just for gold, but across the board.

And now for the good news..Here's something positive to take away from this. I have been looking at the duration of bear and consolidation phases in gold since this bull market began. And this is a chart I'll be showing to all.........

The red line marks the top of gold's channel. The blue dotted lines mark the consolidation periods from interim high to breakout to new high. The green dotted lines mark the period from the interim high to the low from which it sets off on its next run. The longest duration from high to low was in 2008. It lasted nine months. This bear phase has been about eight months.So we're in the timeframe for a low. I’m willing to be patient. Gold remains attractive. Although it has had a less-than-stellar year so far......

Hang on to gold

Consider what US financial newspaper Barron’s recently said in its editorial ;When asked if they could imagine another Lehman Brothers-style event, most analysts responded: "It's just a matter of time. This financial system is completely unsustainable… The ability of governments to sustain the unsustainable ultimately rests on their ability to maintain faith in their creditworthiness...” If this devaluation of financial assets proceeds apace and the moment of clarity comes for many investors in the West who realise they need to diversify into assets that can protect against devaluation, demand for physical gold has the potential to rise dramatically."

The beauty of gold is that it offers a chance to protect against both deflation and inflation. It's difficult to point to gold's credentials as a deflationary hedge because prior historic periods of deflation occurred when its price was fixed. The most recent deflationary period was limited to Japan, at a time when the rest of the world economy was booming. But as deflation (in financial asset terms) is associated with acute financial stress, it seems reasonable to expect gold to provide some diversifying relief from that stress. Particularly because (unlike sovereign debt, for example) it is nobody else's liability.

And as an inflationary hedge, it is worth noting that gold has remained a store of value for literally thousands of years. Gold is also now getting attention from the unlikeliest of sources. Bond fund manager Bill Gross of Pimco recently wrote: "As [investors] question the value of much of the $200 trillion which comprises our current [monetary] system, they move marginally elsewhere – to real assets such as land, gold and tangible things or to cash and a figurative mattress where at least their money is readily accessible." In short, investors are faced with a choice between vast abundance (in paper assets and all things debt-like), and genuine scarcity (tangible and real assets, especially gold). In a de-leveraging world and in light of the ongoing financial crisis, it makes sense to vote for scarcity

And there’s a good reason I think you should own some gold. I’ll show you why...last week was a big news day. The markets eagerly awaited news on interest rates and ‘accommodative measures’ from a batch of central banks. In the end, nothing came – well, not what the markets were hoping for anyway. No big ‘QE’ announcement and no drop in base rates. Just a collective central bank battle cry along the lines of:“We will do everything necessary to get these economies back on track. We will not baulk at our duty. We are preparing the big guns. Nuclear if need be...”The battle lines are drawn

In case you need a reminder, the battle lines are drawn between paper (you know, all the promises written down on bits of paper) and real things. I use the gold price as a barometer of which side is winning. And gold confirms we’re in the middle of the ‘great grind’.

Gold’s gone practically nowhere all year. It’s as if a ceasefire has been called. But now the paper debt generals tell us they’re about to break cover – they’re just readying themselves. But there are different views from the central banks. In Europe, it’s a matter of diplomacy. The ECB’s lieutenants are busy negotiating exactly what is legal in this war. How far can they go? The ECB has already shown a willingness to buy the bonds of its distressed allies. Now, they plan to give aid directly to embattled governments and their banks. It’s just a matter of negotiating the terms with the northern allies. Germany in particular?

For the US Fed, it’s a matter of timing. With presidential elections looming in November, the generals need to wait. But make no mistake, they’re preparing for war. And in this war, they fight fire with fire, or should I say paper with paper. That is, they plan to cure the economic ills (too much debt) with more of the same. Ben Bernanke is utterly convinced that this will work. The Fed’s statement said they "will provide additional accommodation as needed to promote a stronger economic recovery" – so the only question is when?

Their tactics are increasingly desperate....The likes of Ben Bernanke thought they had this battle won before it even started. Simply issue more paper and hey presto – the battle is won.But here’s the thing. They can’t get the cash to flow round the economy. Sure, you can flood your chosen banks with cash. You can even tell them you want the new money lent out and into the economy. But telling a bank what to do is one thing – getting them to do it is quite another. And anyway, the banks need the money now. They’ve got to reimburse the customers and to pay fines for malpractice on other things like Libor rigging.

Money is not flowing as it should. Right across the globe, economies are stagnating. Governments, the public and corporations already have enough debt... they’re trying to pay it off, if anything. But of course, that won’t stop the central planners. Convinced that they are fighting a just cause, and convinced of their state of the art weaponry, they’re still up for a fight. Given that the authorities have started down the road of money printing, I think it’s inevitable they’ll continue with more of the same. It’s impossible to know exactly how this pans out for your investments. Economics isn’t science after all. It’s not physics or maths – there are no natural laws you can fall back on –And this war is based on authorities’ dogma, that they can control economic growth with monetary policy.

That means zero interest rates to drive new debt formation. And because that doesn’t work, it means printing money to help create negative interest rates (where inflation outpaces returns on savings). The central banks are primed for the next assault. The Fed and the ECB acting in unison will be quite something to behold. To my mind, the scene is set for gold’s next run-up. The more paper the planners throw into battle, the higher gold tends to go...

one could recall in more detail about the currency crisis in the Austro-Hungarian empire1919: the year another European currency union died. There are some interesting parallels between what happened then and what’s happening now. The concern is that if Greece is finally forced out of the euro, the crisis will burn quicker and brighter than ever before. Like Austrian and Yugoslavian savers in 1918, there'll be a race to evacuate wealth from the periphery before its too late. Indeed, money is already fleeing the area. Spain and Italy are the latest countries in the market’s crosshairs and savers there are migrating to gold in a large way as we speak.......



First Published: Wednesday, August 29, 2012 - 19:41

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