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Monday, August 29, 2011

Gold's Prophets Of Doom

Investing today is hard enough and just when you find a sector that you think will help your portfolio recover from the battering it has received over the past few years it falls apart. Investing in any sector of the market makes one feel a bit like the guy who drives the caged Jeep at the driving range collecting golf balls, while they know full well that people are teeing up with the full intent of being able to hit the moving vehicle with their drive, whether they admit it or not.  One of the arguments that is commonly used to justify why all of us sheeple should not be investing in the “metal of Kings” is that it is an emotional investment and requires a “greater fool” to drive it higher, as opposed to mainstream stocks that have earnings and cash flow to justify their valuations and when that is not enough we are to rely on tried and true valuation methods like eyeballs, hit counts or some other bogus metric.  The greater fool theory lives in stocks as much as in metals, where people delude themselves that the price they pay for a stock today will be worth more based upon assumptions of future cash flow that may or may not materialize.

If you are following my blogs or Twitter posts you have pretty good idea of where my thinking lies regarding the general economy and the stock market. I am by no means a gold or silver bug, although I do hold a percentage of assets in the metals via allocated closed end funds, along with other precious metal and regular equities.  I do understand and respect the value the metals bring to a portfolio, maybe because of my parents European background.

The lack of understanding and use of the metals in finances is really more of an American cultural bias partially driven by the FED, Wall Street, Government and misguided Keynesians. In many other areas of the world the metals are not only part of the culture but also have a place in finance.  People around the world view the metals as a store of value, something that can’t be printed up or debased at will by a government. To people around the world the metals provide the foundation of their savings and has for generations.  People in the US always use that tired statement that you can’t eat it and it doesn’t pay interest along with other Wall Street logic. You can’t eat stocks either and many of them don’t pay interest ie.. dividends.

Enough digression into my philosophy regarding the metals instead I want to focus on what is going on with them. As gold was making its run to $1,917.10 I could see the mood was becoming euphoric and began tweeting that one could contemplate putting on a hedge for safety’s sake. I am not pointing that out to gloat but instead to show that you need to keep a cool head while everyone else has stars or Dollar signs in their eyes. Of course we all know what happened gold hit is high and was trumpeted from the roof tops by CNBC and alike and then promptly began to decline. Yes things were getting a bit frothy but once the decline began I fail to see why the CRIMEX had to raise margins to exacerbate the decline. I find their excuse about curbing volatility (I know they have a formula) pathetic as they only seek to curb it on the upside but their requirements never seem to be concerned with the shorts and downside volatility doesn’t bother them, but that is a different story for a different day.

Let’s take a look at the situation since the drop. Gold has declined and out of the woodwork as usual came the bears or bearish minded people not that I mind them as it confirms for me that there still is another side to the trade and not everyone is onboard. After all you will need suckers to sell to at the actual top. Everywhere you turn now all you hear is that the “Gold Bubble” has burst and everyday there are calls by so called experts for lower and lower correction prices.  One must remember that these are the same guys that missed the run up and continually called the top for years.  As a gold investor one should welcome these corrections to be able to acquire more metal at a better price even though it is human nature not to want to see lower prices and profits temporarily eroded. The reality is that the Gold market was beginning to go parabolic and had this correction not occurred gold truly could have become a bubble and fallen below its intrinsic value. If gold did put in a exhaustion top then ask yourself where would you be safe to park your wealth and ride out the reorganization of the world monetary system?

Gold started this leg of it historic run on July 5th when it hit bottom at $1486.20 and peaked out almost 1.5 months later at $1,917.90 a move of $431.70. When trying to project where prices of various securities or assets are likely to go I have found that using Fibonacci retracements are a pretty accurate method.  

Fibonacci retracement is a method of technical analysis for determining support and resistance levels. They are named after their use of the Fibonacci sequence as discovered by Leonardo Fibonacci one of the greatest mathematicians of the dark ages. He noticed that certain sequences of numbers occur in nature and subsequently people who study markets have found use of his discovery.. The idea behind Fibonacci retracement is that markets or a security will retrace a predictable portion of a move, after which they will continue to move in the original direction

In the markets the Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8% and 100%. Using Fibonacci levels helps one stay more focused on reality and tune out the doomsayers who are making outrageous calls. I am convinced that all these people that come out with these highly negative predictions are not only bearish on whatever they are making the call (for any number of reasons) but I believe that they are hoping to place a bet on an outlier. What I mean is they are trying to make a name for themselves and because they either don’t have enough knowledge to make accurate calls or they are gambling that they might achieve notoriety by having the outrageous miraculously materialize. No matter whether you have invested in Gold, Stocks, Bonds or whatever these guys and gals are always out there doing this sort of “bashing”.

Back to Fibonacci in terms of this gold run. The move was $431.70 from bottom to top. Below I have placed a chart showing the Fibonacci levels and the corresponding dollar value of the drop and the price at the specific level.

On this current correction the gold price retraced almost exactly 50% of its move which is a very common retrace for a large move. I had been expecting a retracement of 50% with an outside possibility of the 61.8% retracement since there was a breakaway gap at about $1,673 where the price had jumped higher. If you follow charts there is a saying that gaps get filled, and while they usually do there is not iron clad law that they must be filled. Regardless I thought there would be a possibility that a test of the 61.8% retracement in order for that gap to get closed. Instead what we saw was a pull back to the 50% level not once but three separate times in the same day before Gold bounced and put in what technicians would call a “hammer” indicating a trend reversal or bottom on Thursday accompanied by strong volume. The bounce on Friday was very healthy and also on excellent volume but in my opinion in typical gold fashion it overshot too much to the upside. I personally would have been happier if it would have had the same volume and closed around $1,785 and that would have set us up better for today, but as the Rolling Stones say “you can’t always get what you want”.

Today Gold dropped down in to the $1,780s which is over a 3% move to the downside, however, volume declined appreciably on the day indicating less selling. I know those who own the yellow metal would like to see it jump to the upside everyday but that is just as unrealistic as the calls for a drop to $1,250. Nothing goes up in a straight line not stocks, not planes not even gold can defy the laws of physics, for if they do go straight up they tend to fall back to earth with terminal velocity.   

Since Gold hit its current high on 8/23 I have seen a ratio of 13:2 bearish vs bullish articles regarding gold. The current situation reminds me more of the battle of gold $1,500 where back in January of this year the Barbarous Relic bottomed out at $1,309.10 on the 28th and then proceeded in a spectacular run to a high of $1,571.40 (5/2) a move of $262.30. Then like today Gold peaked out and there were any number of bearish articles and the metal retraced just under 50% of its move testing down to $1,462.50 on May 5th or a move of $108.90. At the May price level that $108 was about a 7% price swing. In the current correction the numbers are larger so the swing while roughly 3% greater in size the amount of dollars in the swing has doubled. I point that out because as gold continues to march to its ultimate peak the dollar value of the corrections will be larger and more dramatically reported  which will also serve to keep people out of the market as they will be feed a constant diet of why the metal is risky and they should fear it. Of course the swings in the purchasing power of their currency will be as extreme if not more to the downside and they like many throughout history will not understand why it is happening.

At the moment I do not see any meaningful changes in the world that would change the long term trajectory of gold or silver for that matter. All the fundamentals are still in place and those of you who follow this market or have read my many missives know the reasons that gold and silver are rising. The plain truth is that the metal just plain got ahead of itself and needs a rest before going into its seasonally strong period. After the drop in May it took gold a second retest at the beginning of July for Gold to kiss the $1.500 level good bye and get us to where we are today, and this took placeat the beginning of the summer traditionally the weakest period for the metals. It is my contention that the gold doomsayers are wrong and that the metal is going to consolidate around this area and possibly (although I think it is a low probability event) retest the $1,702 level before ramping up again. It would be healthy for gold to back and fill here for a couple weeks and build a base from which to recapture $1,900 and take out $2,000 in the fall seasonally a gold friendly time of year.

We have heard all the gold naysayers and their tired arguments and they sound like a broken gold record. At the moment the problem child EU is finishing off their vacation month and soon enough it will be back to business and I believe that is when the fireworks will restart, since the cracks are already showing and there like here things are only band aided or smoke and mirrors. The governments of the West are running out of road to kick the can down, but they will try. All of this is gold positive which is why I believe that much more support exists for the yellow metal than the naysayers believe.

Let’s look at the charts below :

This first chart is of the US Dollar. The Dollar is contained within this descending triangle and looks like it is biding time before it continues on its downward path. The Dollar is not in an oversold situation and while it has not broken down it really has not had the ability to rally with any significance. There are many that argue the Dollar is about to enter a multi month rally, but the chart does not say that to me.

The next chart is one of gold that has been circulating showing a head and shoulders top forming. I don’t buy this for a couple reasons. First, this formation only really shows on a line chart with end of day prices and it is short in duration. Second, head and shoulder tops especially when they are this small have a tendency to not get validated as they may not complete or may complete but still not be of significance. Moreover, look at the chart immediately following from 2009 when the gold market was arguably under a lot more downward pressure and you can see the same formation that the naysayers were touting then and they were wrong. Instead I would submit this is too easy and instead it is a bear trap.

Lastly let’s look at today’s gold chart in candlestick form where things look clearer to me. Gold opened today with the excess left from Friday’s continuation of the snap back rally and proceeded to drop. Notice the volume on the chart declined and the overbought condition is relieved on the RSI at the top of the chart.  Additionally the entire correction has still essentially occurred within the confines of the uptrend line and the supposed neckline from the head and shoulders intersects with the uptrend support at about $1.750.  My hope is that gold grinds sideways here and works off some of the remaining exuberance before continuing higher, but gold has a mind of its own and will do what it wants. If we do get a retest in price I believe it will be an opportunity to add or load more. To paraphrase Ronald Reagan, Ask yourself is the economy and the underlying situation that has brought gold to these levels any better now than when the bull market started? The answer to that question will determine if you will buy more on a dip or sell in to any panic.

1 comment:

Gold Rate Today said...

I think Americans were just fed propoganda by the financial services industry that gold was risky. So most people will miss out the bull market.

Anyway, you go to great detail with some excellent observations. I'm also looking for another test or at least a triangle consolidation here in the short term.

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