Friday, January 2, 2009

Reconsidering Gold

Back in August, 2008, I wrote an article about gold essentially stating that the biggest threat to price appreciation in gold was price appreciation in the US Dollar Index. At that time, that was a good "call" as the the US Dollar Index is up about 10% from the July 31, 2008 close and gold is down about 5% from that time after having been down as much as 25%. I based that assessment of gold and the US Dollar Index on my "next big thing" indicator which looks for secular trend changes. Based upon this metric, the US Dollar Index looked better than gold than, and it still does so today.

So fast forward to today and we see that gold has closed the month above its simple 10 month moving average and above a down sloping trend line formed by two prior pivot high points. See figure 1, a monthly chart of gold. Typically and on a purely price action basis, I would consider this bullish. However, for gold, these technical milestones have failed to produce any meaningful edge especially when we apply other filters of the price action (such as the "next big thing" indicator). In other words, I don't believe that this represents the beginnings of a new secular up trend in gold.

Figure 1. Gold/ monthly

The "next big thing" indicator is shown in the lower panel of figure 1, and essentially, it is not in position where we would expect a new secular up trend in gold to develop.

As far as the US Dollar Index, I believe there is still some upside left in the current price move. Figure 2 is a monthly chart with the "next big thing" indicator in the lower panel. The indicator remains in a position (like back in August, 2008) that suggests a new up trend should develop. Furthermore, moves in the US Dollar Index typically end with a some sort of negative divergence between price and an oscillator. In other words, you don't see price thrust off the bottom (like it did in August, 2008) and then just fall apart. It would not surprise me to see the US Dollar Index test and fail at the December, 2005 highs. This is at least several months away.

Figure 2. US Dollar Index/ monthly

The obvious is that this analysis goes against the consensus opinion. The consensus opinion is that the Federal Reserve is printing money to do whatever it takes to cure the American economy. This is inflationary. And obvious to all observers.

However, the following isn't so obvious: despite all the creation of money, money is not being lent as lenders are reluctant to lend or borrowers are unable to borrow or money is going to pay off debt. I am grateful to one of our readers who sent me a chart of the M3 Money Supply (estimated) from John Williams' Shadow Government Statistics. Growth of M3 Money Supply and gold price appreciation should be roughly correlated, but what we find is that M3 Money Supply is decelerating despite the Fed's Herculean efforts. Essentially, money is not finding its way into circulation.

You can find the chart of the estimated M3 Money Supply by following this link.

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