MARKETS SPECTATOR: All that glitters...

There's been a lot happening on the gold front, but despite the spruikers the price action suggests a downside risk.

Gold has once again been making the headlines due to rather large, volatile moves. The overnight price action saw another strong move, with the precious metal breaking down through the $US1700/oz level to trade as low as $US1691.35/oz before managing to close the US session at $US1695/oz.

It was its lowest level in more than a month as a number of big sell orders caught the market off guard. On top of that, there has been some interesting trading activity in the options market too with a little over 13,000 options contracts changing hands in the first few minutes of trade on Friday.

And there was a warning sign the day before with a large chunk of January $US1700 put options bought. Put options are bought when a participant believes the price of gold will be below the $US1700 level by the expiry date in late January.

Fundamentally or technically, there really isn’t one factor to blame for the recent eye-catching moves. Rather, it's likely a combination of many factors including hedge fund liquidation, technical price triggers, end of year book squaring and tax-related selling (this is a big one given the real prospects of significantly higher taxes in the new year should the US economy go off the cliff).

The last three or four years has seen gold trade as a safe haven given all the problems in Europe and the hangover from the GFC. However, the last six months or so has seen gold trading less and less as a safe haven as investors have slowly developed enough confidence to wade back into other asset classes, especially equities.

Gold is in a long-term uptrend and is on track to book its 12th consecutive year of gains. However, since hitting an all time record high of $US1920/oz in September 2011, price action has basically turned sideways.

During this period, it's had some pretty wild swings, hitting lows around the $US1530/oz level on three occasions before finding good buying support and rebounding higher.

I’m not outright bearish but I’m certainly leaning towards the downside rather than further gains. I understand the argument for higher prices and all the reasons supporting this view but from a price action point of view, it’s a very mature bull market.

From a positioning perspective, it’s a very crowded trade too as a lot of participants are holding long positions. And there’s a pretty strong chance they are sitting on large paper profits. We’re already starting to see signs of increased selling pressure and I don’t think it would take too much to trigger a lot more profit taking, which would quickly erode confidence.

Looking at it from a different perspective, I ask the question who is left to buy?

Any of the big institutional money that wanted to buy gold did so a long time ago. Now, in my mind the only buyers are the retail players, which is a warning sign on its own.

Another aspect that worries me is the huge and outrageous price targets being bandied around by so-called gold experts or ‘bugs’. The latest one I came across is from Peter Schiff, famed for predicting the GFC. He has basically said that gold will get to $US5000/oz within two years.

There’s only one thing this reminds me of; Goldman Sachs calling oil to $US200/bbl in March 2008. If you don’t remember, it fell to $US33.87/bbl from US145/bbl in just under six months.

So while my gut sees downside risk, this is definitely a case where I would wait for the price to tell me which way it wants to go.


On the above chart, we can see the range that gold has found itself in for the last year and a half. There is strong supply around the $US1800/oz level while on the downside, there is strong buying around the $US1530 level.

The rising trend line, combined with the short-term downtrend line is making a triangle pattern. As the price approaches the narrow end of the triangle, we would expect to see some sort of volatile breakout. As it stands, given the long term uptrend and current prices the odds would favour an upside breakout.

However, if gold did manage to break the uptrend line and test support around $US1530/oz, then the odds of a downside break would rise very quickly.

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