What is Gold Telling Us Abut Risk Appetite?

November 22, 2009 · Posted in Weekly Posts · Comment

Gold has been behaving rather oddly these last two weeks. In the face of an overbought market, a crowded market by all accounts, and in the face of a directionless dollar and weakening stock markets gold has stayed fixed at the elevated level of $1130- 1153/oz. As can be seen from the USD chart below, the dollar has been trading pretty much sideways for the last number of trading days. Gold in fact was up Friday despite the dollar also being up. Many are saying gold is in a bubble. Their reasons are that 1) physical demand is weak - true, 2) most of the price movement is being driven by the futures market and ETF inflows - also true, and 3) that gold’s price action is a sign of speculative excess - nonsense based on examining previous bubbles, and finally 4) that everyone is talking about gold - meaningless as an indicator.

It is true that physical demand today is weak but we believe that the gold price is expecting the near future to see rising central bank and pension fund interest in gold. If that materializes then that buying will dwarf the jewelry and personal investment demand. Just as stocks tend to be forward looking in their price movements so too is gold pricing in future strength in the market. This is also behavior that is consistent with the fundamental change in the gold market that we are experiencing. That is, one where paper currencies are coming question.If this buying does not materialize then gold is at risk of a price plunge but this buying is not something expected tomorrow. We think the market will wait.

As for the crowded trade nature of the market. It is true that much of the current price action is in the futures arena (consistent with our view that gold is behaving in a forward looking manner). That is a risk if there is a sudden downdraft in stocks and funds need to raise cash. Futures are on margin so they need to be exited quickly if they go against you and are a source of liquidity when needed. This is a risk for gold.

What about the idea that we are seeing speculative excess in the price? We reply - nonsense. If we were seeing wild speculation we would expect much larger daily moves in price. Think about the following: since its breakout around $980 gold has risen to $1152 (approx) as its high - a $172 move in just under 3 months, an 18% move. That is not a bubble just because it had a good run. That is a breakout move after a year long consolidation. We will know when we are near a peak when we see large moves day after day in the price of gold and when those moves exceed the moves previously seen. Show us an $80 day move and we will start worrying about a top.

Finally…”but everybody is talking about it!!!” Everybody is taking about the economy and stocks as well. So what. Gold is in the news because paper currencies are in trouble and investors are looking for a store of value. You may also notice that “spot the bubble” seems to be the game all the pundits are playing now. We have never seen so many pointing out so many “bubbles”. They see bubbles now everywhere.

Bottom line: gold needs to correct and consolidate. When it does add to your positions. If you have profits now, take some off the table and buy more when the correction occurs. Gold looks set to stay strong even in the face of weakening equity markets. We believe that gold investment will start rising in the face of equity and currency weakness. That is, gold will begin to replace the dollar and US treasuries as a store of value.

As for world equity markets the charts below do not paint a rosy picture. The US markets are clearly weakening and there is little that is ahead in the next few weeks that could provide the needed excitement to send them much higher. Best case is we will trade sideways. Worst case is we could see the start of a sell-off. Of the overseas markets China looks strongest though it is at a level that one can expect a correction. Brazil may just be starting to weaken, Australia looks like the Russell 2000.

In all this is a time to manage risk tightly and not stay too overexposed to anything for too long.

Below are the charts for the USD, Gold, S&P, Russell 2000, Shanghai, Australia, and Brazil