Why Gold Has Further To Fall
Though a gold bull, I called for a correction late last year and believe more downside is likely from here. There are three reasons to be cautious on the near-term outlook: 1) gold has historically performed weakest during the March-July months 2) sentiment towards gold has turned somewhat, yet there’s been little capitulation, particularly from the world’s central banks 3) the current correction has been relatively mild – remember that gold slid 47% during its 1970s bull market before peaking in 1980. It makes for reasonable odds that gold will dip below US$1500/oz in the first half of this year. If that happens, it will be a major buying opportunity as there remains a strong case that the bull market in gold is far from finished.
In December last year, I suggested that the odds favoured a more serious decline in the gold price. After 12 straight years of annual gains, a sharp correction was overdue:
“The recent correction isn’t as severe as the 2008 correction of 29% of the 2006 correction of 22%.
Corrections of +30% during bull markets are more common than not. During the 1982-2000 U.S. bull market, the U.S. market had many corrections along the way, including a 34% correction in 1987. It didn’t stop that bull market.
And gold itself corrected 47% from 1974-1976 before rising more than 8x to US$887/oz in 1980.
The point is that the current correction isn’t unusual and isn’t severe. And a more serious correction in gold at some point, perhaps now, could happen before the final phase of the bull market begins.”
I went on to cite a few warning signs indicating there might be an imminent correction. At that time, speculation in gold had reached extreme levels. At one point in the fourth quarter, the number of call options – betting on a rising gold price – outnumbered the number of put options – betting on the opposite – by 2:1.
In addition, the accumulation of gold by the world’s central banks warranted caution in my view. Traditionally, central banks had been terrible investors. In effect, those banks buying gold was a contrarian signal.
A Confluence of Negative Events
Since that time, there have been a number of things which have contributed to pushing the gold price lower. There’s been a growing view that the U.S. economy is recovering and rising real rates are on the way. This would be bearish for gold, which has benefited from negative real interest rates – low yields on alternative asset classes makes gold more attractive. I’ve taken issue with this view on several occasions but, nevertheless, it has been a factor in the falling gold price.
Also, the U.S. Federal Reserve has signalled that it may consider slowing asset purchases as worries emerge over fuelling asset bubbles. Obviously, slowing central bank balance sheet expansion would be negative for gold. How anyone believes that the Fed will reduce money printing soon is beyond me, but it’s a view that’s being taken seriously nonetheless.
Receiving much less coverage has been the fact that gold demand has been falling. In 2012, gold demand fell 4%, despite central bank gold purchases reaching 48-year highs. Gold purchases by the world’s largest gold consumer, India, fell 12% as a rising rupee and higher import tariffs took their toll.
Gold also breached several key technical levels at US$1,600/oz. It entered a so-called death cross in February, where the 50-day moving average price crossed the 200-day moving average. Pity the death cross has no predictive value whatsoever, as pointed out by asset manager and blogger, Barry Ritholtz!
Lastly, speculators who had been piling into gold last year started to trim their holdings or head for the exits. For instance, billionaire George Soros cut his stake in GLD, the U.S.-traded gold ETF.
Gold Below US$1,500/oz?
There are good grounds to think that gold may have further to fall. March has traditionally been the worst performing month for gold. The second quarter isn’t usually much better. The March-July period coincides with weak seasonal demand for gold. Demand picks up in the second half of year in the lead-up to India’s Hindu festival of lights, Diwali.
Also, gold is very close to breaching key technical support levels. If it goes through the May 2012 lows of US$1,536/oz, it would likely trigger a wave of selling. The next support level beyond that is US$1,400/oz.
While sentiment among gold speculators has turned more cautious, there hasn’t been the outright capitulation that you usually see during serious corrections. Breaching US$1,536/oz levels could trigger this capitulation.
And as mentioned previously, several corrections of +30% during bull markets are perfectly normal. Gold’s steepest decline during this bull market has been 29% during 2008. It would hardly be surprising to see a sharper fall. If gold was to correct as much as it did during the 1970s bull market, it would fall close to US$1,000/oz. That said, I don’t expect it to fall to those levels during this correction.
Remain Long-Term Bullish
If I’m right about a further correction in the price of gold, the coming months will be a test for even the most ardent gold proponents. It’s worth keeping in mind though that the current bull market in gold is likely far from over, for the following reasons:
- Commodity bull markets have lasted an average 18 years over the past century; the shortest bull market was 14 years. We’re into the 13th year of the current gold bull market.
- Bull markets always end with parabolic spikes. For instance, gold went up 4x in 13 months during 1979-1980 and the Nasdaq climbed 171% in 17 months before peaking in January 2000. Gold hasn’t had this spike this time around.
- Retail investors have minute exposure to gold. During bull markets, the general public invariably gets enamoured with assets whose prices are rising. We just haven’t seen this kind of enthusiasm towards gold.
- More fundamentally, gold remains the best hedge against currency wars. My base case remains that the extraordinary money printing from the world’s central banks is unlikely to end well. Historical experience says so. I expect the experiment with money printing will end when sovereign bonds are no longer considered safe havens and government bond yields spike as a consequence. It’s then that quantitative easing and the current fiat monetary system will be discredited. And that gold will once again be viewed as the ultimate safe haven.
Though short-term caution is warranted, I eventually see gold testing, and possibly going well beyond, its real all-time high near US$2,400/oz. If you’re looking for alternative ways to play precious metals, silver should outperform gold from here given the current gold to silver ratio is 56:1 compared with the 16:1 long-term average.
Source: Asia Conf.
About James Gruber
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