MARKETS SPECTATOR: Losing its lustre

The inflation assumption on which the gold rally was built is simply not coming to pass. Now the major support level looks under threat.

It’s fast becoming obvious, especially to those with long positions in gold or gold stocks that things aren’t all going to plan. Actually, far from it.

As central banks around the world continued to ramp up the printing presses and investors continued to seek out safehavens, gold was supposed to and expected to keep marching on its merry way higher. Well, for all those participants that bought above the $US1610 per ounce level, they’re now in negative territory, which is a very bitter pill to swallow, especially against a backdrop of surging equity markets. Now, it’s pretty clear that all this was already priced into the market.

The problem with gold is that there is only way to make money; simple price appreciation, which is why many refer to it as a giant Ponzi scheme because if there isn’t somebody willing to pay more than you paid for it, then you’re in trouble.

In short, the main thesis behind long gold positions was that printing more and more money was going to cause a huge problem with inflation. Well, this hasn’t happened and there isn’t any sign of it happening any time soon. Now that doesn’t mean it won’t happen, it’s just that there aren’t any signs of it yet.

So a lot of big money initiated gold positions on the back of this premise. Now that this is being severely tested, we’re beginning to see money flow out of gold investments at an increasing pace.

I’ve been sceptical on gold for a while simply because of the outlandish and ridiculous calls of seemingly brainwashed gold bulls calling for gold to be $US2500 by mid next year, or even $US4000 or $US5000 by now.
The whole thing reminds me of early 2008 when Goldman Sachs called oil to $US200 per barrel. It was trading around the $US140 mark. Little more than seven months later, it bottomed out at $US33.

The other things that have had me worried are, one, it’s a very mature bull market, two, it’s a very crowded trade, three, who is left to buy, and four, with everyone positioned long, there were and still are a lot more potential sellers than buyers.

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The above chart shows the significant underperformance of gold stocks over the last five years with the S&P/ASX All Ordinaries gold index likely headed for its 2008 lows.


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In the long-term chart of gold above, we can see that the long-term uptrend from the 2008 low to the 2011 peak has been broken to the downside and that it is now acting as significant resistance. Also, since the highs of 2011, gold has been steadily making lower lows, which can be seen by the short-term downtrend line, which is acting as upside resistance, too.


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Switching our attention to the shorter term chart above and we can clearly see that we have real battle on our hands. Since forming a short-term high in September 2012, the bears have been in some sort of control, slowly pulling prices from around the $US1800 level down to $US1600, where we are today.

However, it was only when the price broke down decisively through the crucial support at $US1626 that it was obvious the bears had completely overhauled the bulls. If there was ever a time for the bulls to step in, it was around that key support pivot point.

This break down lower now opens up the very real and likely prospect of a test of the major support zone around the $US1523 to $US1550 levels. We may even get a break down through there but I would expect to see a last stand from the bulls, which will likely result in a significant bounce and one last hurrah.

How far and high this bounce goes will go a long way to determining whether or not the price really collapses. If it can’t bounce from the major support zone then it’s in real trouble. In my view, a trapdoor would open below the $US1500 level which would likely see a collapse in the gold price as everyman and his dog looked to sell their bullion position.

Ultimately, it is this reaction around this major support zone that will decide the precious metal's fate.