Thursday, April 30, 2009

Gold: On The Launching Pad

I love to chronicle my follies with gold.  Gold seems so easy.  The Federal Reserve runs the printing presses, and everyone in the world knows this is inflationary, and just like that, gold should be off and running.  But it isn't.  

But in retrospect, my gold exhortations haven't been so bad.  Back in August, 2008, I was less sanguine about gold primarily because I was bullish on the Dollar.  When others were bullish on gold back in February, 2009 -as in we are "going to the moon, Alice!" - I was stating that this was not the set up where gold should go higher.  This too was a good call.  The best I could muster was that gold would remain range bound.  

And range bound it has been, and we can see that in figure 1, which is a monthly price chart of a continuous gold contract.  The indicator in the lower panel measures the degree to which prices have become compressed, and presently, gold prices are compressed to a statistically significant degree. 

Figure 1. Gold/ monthly 

What we do know is this: compressed prices can lead to explosive moves in either direction.

What we don't know is this: what direction that it will ultimately be.

So this period of consolidation in gold (and most other assets) meets my criteria for a set up that can act as a launching pad for higher prices.  But it can also be a launching pad for lower prices, too.  

And that is the dilemma.  I wish I had an answer, but any technical indicator that I have for you would only be curve fitting in my opinion.  But all is not lost as the current set up offers a low risk entry for going long gold.

So let's take another look at the monthly price chart for gold.  See figure 2.  As long as prices stay above the pivot low at $884.80 on a monthly closing basis, I can remain constructive on gold.  Gold is now trading in the low end of its range.  When the bull market in gold began in July, 2001, gold has (almost) always closed above its prior pivot low point; this is a hallmark of a bull market -higher lows.  The lone exceptions to this rule are: 1) highlighted in the oval when the price of gold closed below the prior pivot for only one month before moving significantly higher and 2) highlighted by the red down arrows as this was the close below the prior pivot low point that effectively "killed" the bull market.

Figure 2. Gold/ monthly 

Now let's look at a weekly chart of a continuous gold contract.  See figure 3.  The breakout (price bar with red arrows) above the down sloping trend line has pulled back to support levels of the down sloping trend line and the pivot high.  This looks like a retest of the breakout (inside the oval), and in my "textbook" this represents a low risk entry point.  On this weekly view, a weekly close below $870.70 would like lead to lower prices.

Figure 3. Gold/ weekly

So let's summarize.  Gold is on the launching pad; gold is trading within a range and it is at the lower end of that range.  We accept the fact that we cannot predict the direction gold will take.  Prices could either breakout or breakdown from this range.  Once we accept this condition, I believe that the current price represents a low risk, well defined entry point.  A monthly close below $884.40 is bearish; on the SPDR Gold Trust (symbol: GLD) this pivot comes in at $86.65.  A weekly close below $870.70 is bearish as well; for the GLD this pivot is at $85.12.  

If these levels hold, then gold bugs may yet have their Ralph Kramden moment (i.e., hit the big one). 


dacian said...

Thanks for this new blog.

As I went quickly through some of your previous posts on gold, I saw you always looked at the dollar when analyzing gold (actually vs. a basket of currencies, but there was a post comparing dollar with gold).

This bear is due to a credit event. Hence, when you have extremes in the markets (world is falling apart, hyperinflation, depression), gold does well. We noticed there were moments during 2008 and 2009 when both the dollar and gold moved up in tandem, which is something I can understand as we witnessed extreme stress (everyone pays back debts hence big demand for paper dollars, gold is safe heaven).

Now given that you see a low risk entry point for going long gold, the question is what about the dollar? If we switch to "big inflation expectations", then gold will go up as a protection against that (but the same will do other metals and commodities, together with energy stocks, miners, etc. and this might send the broad markets higher as well). This is in contrast with your other post stating we will see a decline in the broad markets over the coming weeks. But if we assume the "deflation trading" resumes, both the dollar and gold will move up, and markets will go down, which is more in line with your other post on how the broad market will move; so what's you thought on the dollar now? thx

Guy M. Lerner said...

Dacian: you are welcome with regards to the blog....

Honestly and I kind of alluded to this with regards to gold is that I have uncertain ease when investing in gold. What seems to make perfect sense for gold doesn't seem to work out. I am just acknowledging this fact.

Your summation of my past comments is correct.

I still think the bull market for the Dollar is intact in that I have not gotten a sell signal on the model; there is some suggestion of weakness when looking at price alone, but when you take some currency cross pairs (USDJPY, USDCHF, USDCAD),I think the Dollar has a good chance to lead these currencies. So this is mixed.

How will a higher Dollar affect gold is difficult to say; as you noted, in the recent past, both went up together as the markets deleveraged. Both acted as a safehaven.

I will post a chart of gold v. the currencies as previously done but this still shows just a range.

Stock market weakness typically translates to gold strength and this is from data of my own work - not some goofy dogmatic observation. So market weakness means gold strength.

I guess the point of my post was best summed up in the summary. A big move is coming. This is a low risk set up either way - short or long. As I generally play on the long side, this was my focus.

I know this has implications for the deflation v. inflation scenario but in the absence of knowing which is going to win, I thought this was a good way to play it.