Monday, May 24, 2010

Has The Rally In Gold Been Short-Circuited?

While there may be legitimate reasons to think so, Marko's Take is an unequivocal NO!

First, let's review the case against Gold, which has merit.  After peaking near $1,250 per ounce, the yellow metal hit an air pocket which took it down a swift $80 per ounce in a matter of a few days in sympathy with the sudden meltdown in Global stock markets.  The "Gold Bugs" Index (HUI) suffered a steeper decline of approximately 16% from peak to trough.

In addition, the recent strength in the U.S. Dollar has given rise to speculation that, rather than inflating, our economy is DE-flating.  Given the unprecedented drop in money supply aggregates, such as M-2 and M-3, it makes sense to believe that a deflationary meltdown is at hand.

Market technicals, however, do NOT support that position.  The situation in the precious metals and commodity markets appears analogous to that which characterized the NASDAQ in late 1998.  At that time, the internet bubble was well into its mania.  However, the blow-up of Russian debt, the RUBLE and ensuing multi-billion dollar losses of hedge fund Long-Term Capital Management, threatened to throw the entire Global financial system into complete disarray.

The NASDAQ lost 25% in a matter of weeks before suddenly reversing and tacking on about 300% in the next 16 months.  It appears that Gold and other commodity markets are following a similar trajectory.

The graph of Gold below demonstrates that the recent correction still qualifies as no more than a temporary "blip".$GOLD&p=D&yr=2&mn=0&dy=0&id=p43086601386&a=191194388&listNum=1

There have been no technical violations of the uptrend in force since the bottom of the financial crisis in late 2008.  The chart still looks quite healthy.

The recent decline in GOLD has been virtually entirely dollar related.  To show that, we can divide the price of Gold by the USD, or dollar index.  Ideally, it is optimal to see this ratio rise, which would indicate that Gold is outpacing the Dollar.  The converse would show intrinsic weakness in Gold.$GOLD:$USD&p=D&yr=2&mn=0&dy=0&id=p97275561041&a=200986161&listNum=1

Recent trading illustrates that relative to the Dollar, Gold has been in a holding pattern.  This is directly opposite to the period from November 2008 to December 2009, when the ratio rose during the rally from $700 per ounce to $1,200 per ounce.  If we should see this ratio decline, as we did from the summer of 2008 through the November, 2008 lows, we'd have reason to believe that a MAJOR correction might be at hand.

Finally, and more auspicious, is the relationship between Gold and the S & P 500.  Ideally, we want to see this ratio rise as Gold outperforms other financial assets such as stocks.  The chart below shows that the ratio is at its highest level in more than a year and is on the cusp of moving to new highs.$GOLD:$SPX&p=D&yr=2&mn=0&dy=0&id=p52824535369&listNum=1&a=199516559

All in all, GOLD remains on a solid footing.  As the imminent mania in precious metals continues to unfold, investors will need to be prepared for substantial intra-day volatility and violent weekly swings.

We expect there to be huge profits in the ensuing weeks, especially in the junior sector, but investors will need to not get thrown off the bucking bull.  The market is at another ideal entry point.

Marko's Take

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  1. Marko,
    One point I do not agree with you, gold is now acting like its own currency,and is not for the most part dependent on the dollar going up or down .In the past gold would go up when the dollar was headed down ,and vice versa . The USDX is not now an indicator of dollar
    strength but of euro weakness. The euro represents 58% of the index so if
    the euro were to collapse to zero the USDX would approach infinity which
    would not mean the dollar is strong it would mean the euro has collapsed.
    So in this context do not think that gold should not go higher because of
    the USDX rising. The USDX is rising because of a collapsing euro and that
    is driving unprecedented demand for physical gold. So the rising USDX
    is bullish for gold.

  2. Hi RD:

    How DARE you disagree!

    Actually, I don't think we do disagree at all. I have written extensively about "Dollar Strength" being "Euro Weakness", so on that we are completely in sync.

    My point in bringing up the dollar is that since Gold is denominated in dollars, it must have some inverse relationship. That said,in a true bull market, a rising dollar won't matter. Gold needs to outperform the dollar and that was my only point. Today, with the dollar way up, gold still rallied sharply, which is exactly what we would want to see.



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