Wednesday, February 25, 2009

Lamenting Gold

My lament on gold has been well documented, and for the entire move from $700 to $1000, I have been on the sidelines unwilling to commit capital.

My reasons for the cautiousness on gold are as follows:

1) Gold would underperform because the US Dollar Index is outperforming. I discussed this in my February 17, 2009 article, "US Dollar Index: Still Bullish". With gold's recent down draft, the US Dollar still has been the better performer over the past 6 months.

2) The long term technical considerations for gold are not bullish; however, they are not bearish either. I discussed this in the January 25, 2009 article, "Gold: Let's Try This Again". In my opinion, gold needed more time before a multi-month secular move could develop. Then, as now, I view gold as range bound.

3) My last reason had to do with gold's performance relative to a basket of 8 currencies. The currencies that I am looking at are: 1) Australian Dollar; 2) Canadian Dollar; 3) Swiss Franc; 4) Eurodollar; 5) British Pound; 6) Singaporean Dollar; 7) Japanese Yen; 8) US Dollar. The indicator, which should lead the price action, has been lagging, and that is still the case today.

A weekly chart of gold is shown in figure 1 with our indicator in the lower panel. The indicator is calculated by determining the price of gold in 8 currencies. I then calculate a 52 week rate of change of each data series, and combine these values into a single, composite indicator.

Figure 1. Gold/ weekly

Despite the recent rise, gold really has been underperforming relative to our 8 currencies. In fact, the indicator is negatively diverging from price, and this, in and of itself, would make me cautious. Most recent price appreciations (labeled 1 and 2 in the graph) saw the indicator leading the price action. On the recent surge in the price action, the indicator has not broken out yet.

My expectation is for gold to remain in a price range with $900 being the first buying point of interest.

Lastly, let's return to my lament on gold. I cannot tell if my analysis is good analysis or just the old adage of a "broke clock is right at least twice a day". Either way, I will stick to my guns and stay on the sideline waiting for my set up.

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