GOLD: WHAT IS GOING ON?

I don’t pretend understanding gold and I am not trying very hard, acknowledging that so many very smart people have repeatedly failed at it. I see only two “reasonably reliable” indicators on gold: U.S. monetary policy (i.e. it is usually safer not to be long gold when the Fed is tightening) and seasonality (see below). Anyhow, a few good reads FYI:

The history of discretionary monetary policy is one catastrophe after another, and the gold market loves it. Central banks have invented several rules and targets to replace the gold standard because they are aware that an economy works better under stability protected by an anchored standard.

Since 1985, central banks have managed monetary policy with either money growth and interest rate rules or inflation and unemployment rate targets. Gold perma-bulls argue that rules and targets are not firm enough to ensure price stability. In other words, the economic system has an inherent inflationary bias because governments indirectly or otherwise have tendencies to intervene one way or another with the monetary order, manipulate the public and trick investors.

I believe in the above proposition that government does what it can, on the quiet, to influence the conduct of monetary policy especially when the going is tough. Since 1999 economic tensions have been high and monetary policy, for the most part, has been very loose. In the twelve months ended July 2011, the price of gold increased about 7.5 fold to reach $1900 per troy ounce. In essence, gold price, as the theory promised, tracked closely the growing abundance of money and the declining path of real interest rates.

However, it appears that gold prices may have run-up too fast and too far.

1) A recent technical view by Oppenheimer opines that gold, having essentially tripled in price in the past five years, is toying with the prospects of violating the uptrend line that has been in effect since the $700 low in 2008.

2) A recent research paper by Credit Suisse ascertains that the price of gold has never been as high as it is today, in real terms, for this long. The long-term real average price of gold in 2007 US dollars since 1841 is $462 per ounce. Since the end of dollar convertibility in 1971, it is $653.

3) A recent study by Duke University shows that the world stock of gold, estimated at 171,300 metric tons, is currently worth about $9.0 trillion. In 1999, the world stock of gold totalled about 145,000 metric tons for a value of $1.5 trillion. This is equivalent to a 6.0 fold increase in the value of the world stock of gold. During the same 12 years, The US money stock (MZM) expanded from $4.0 trillion to $12.0 trillion for much lesser 3.0 fold increase.

4) As a matter of fact, in relative terms to industrial metals, energy, housing and equities, the price of gold is definitely expensive and has been so for some time.

What is fair value for gold is difficult to discover and, therefore, a matter of debate. Put simply, the “reflation fix” of central banks combined with “rolling financial issues” since the collapse of Lehman Brothers have been the main drivers behind the rising price of gold and treasuries.

Credit Suisse argues that extreme fears that have characterized the world scene since 2008 are dissipating. The bank’s research desk has put forth that the peak in fear trades occurred last July. The point of inflection took place when the ECB President Mario Draghi firmly committed that the ECB would do “whatever it takes” to save the euro.

If this is true, the remaining concerns have to be with what will happen to real rates and the excess reserves at the Fed.

Firstly, the day is approaching for a change in the Fed’s monetary stance. The inflation composition of the misery index (9.6) is rising and currently stands at 18%. At 25% is when the turn will come. In a previous weekly letter, I argued this point. Real rates are still negative but they are slowly moving up.

Secondly, it is possible that bank excess reserves may never be monetized. Prudent management, regulatory restrictions and investor aversion to risk are forcing banks to keep higher liquidity and capital-to-assets ratios. In effect, excess bank reserves are unofficially frozen.

Accordingly, the Federal Reserve Banks could just decide to raise the reserve requirement to a level that would officially absorb all or part of the excess bank reserves. It should be noted that when the Fed balance sheet increased some $2.5 trillion in the two years following the sub-prime crisis, the price of gold shot up $700. In this connection, one could arguably defend the proposition that the $700 is fluff. In this connection, gold prices could trend lower to $1200.

Over the last several trading days, the bottom has fallen out of gold.  In less than three weeks the price of gold has dropped by $100 for a decline of more than 5%.  Just today, the commodity saw a ’death cross’ of its 50 and 200-day moving averages.  The relatively uncommon death cross is considered a negative technical pattern where a downward sloping 50-DMA crosses below a downward sloping 200-DMA.  Death crosses are so rare for gold, in fact,  that the last time it happened with its 50 and 200-DMA was back in 1998!

Going all the way back to 1975, there have only been eight prior death crosses for gold. 

(…) Therefore, from a technical standpoint, gold is getting to a place where a potential trading opportunity may occur.  Historically speaking, when the price of gold has gotten more than 4% below the average price (inverted to display a positive number to display better) it has been consistent with a near term bottom in gold prices.  With gold now 6.7% below is 13-week moving average – the risk/reward opportunity appears to be favorable for at least a short term trade.  However, what investors should not be doing at this point is panic selling into this slide.  With gold on a very serious “sell” signal counter-trend rallies should be used to reduce excessive weightings in gold until the overall trend becomes positive.

Gold-Deviation-022013

As we approach spring and as Fed members discuss the ending of QEs, gold bugs are shivering.

 

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