Will Gold Keep Its Shine?

Gold is one of the few shining lights in a very gloomy February market. Its price is pointing skywards whilst other investments are plunging towards the underworld. So, it seemed high time to take another look at the king of bling.

Recent Performance
In early January, when the world was engulfed in a drug-fuelled haze of optimism, gold popped down to take a look at $800. It obviously didn’t like what it saw because since then it’s rallied by over 20%.

Last Friday’s panicky markets saw the gold price push through the psychological $1000 level. Profit-taking has pushed the price back to the $970 area, but a large body of opinion reckons another assault is imminent and will lead to a test of the all-time high at $1033 (gold has already hit all-time highs against other currencies like Sterling and the Euro).

But check out the chart below; note the similarity of the rallies through the end of the year. I wonder where the gold price is heading now?

If you want to gen up a bit more on gold check out another gold blog I wrote a while ago and an introductionary blog on the influences on the gold market.

What’s Driving The Price?
At a time of collapsing markets, bankruptcies and Ponzi schemes, gold is the daddy of investments because it’s real; you can see it, trade it, and if you’re strong enough you can take it with you.

Gold is typically bought as a hedge against three main scenarios:
1) A falling Dollar,
2) Rising prices (inflation)
3) A major catastrophe (war, financial meltdown)

You’ll struggle to find a weak Dollar at the moment. Check out the Trade-weighted chart provided by our friends at Barchart:

So that’s not the driving force.

Deflation, not inflation, is the word on the lips of most central bankers (except the deluded ECB). But scary stories of governments having to prevent deflation at all costs and predictions of a Zimbabwean-style approach to creating inflation have certainly added to the clamour for gold.

But the driving force is that investors are looking for somewhere safe to store their money. Bank deposits and money funds are no longer as trustworthy, and a 2-3% return on government bonds when supply is more plentiful than hash cakes in Amsterdam lacks appeal, especially if there’s even a whiff of inflation in years to come.

Follow The Bear
No, not the trading bear, the big grizzly Russian bear. Russia’s central bank is under orders to raise the gold share of foreign reserves to 10% and has accumulated 90 tonnes over the past 15 months. Is it too cynical to suggest they’re looking to make a mint when they, or their ex-soviet neighbours, default on loans to European banks?

Downside Risks

1) It’s in the price
Gold is everyone’s favourite trade, but think about it; if something is your favourite trade you’ve probably got it on already. The past week has seen traders price in nationalisation of the US banking sector, the meltdown of Eastern Europe and an Oscar for Kate Winslett. What bad news is left out there to convince new buyers?

2) Sell In Ma(rch)

Ok, hands in the air time; this bit isn’t my own research. I first saw this chart in an article by gold bug Dominic Frisby in Moneyweek and Dimitri Speck was kind enough to lend me his chart from seasonalcharts.com.

The chart shows the seasonal pattern of gold over a 37-year period. The pattern shows a tendency for gold to push ahead during the first two months of the year, but then suffer a setback in March (that happened in a big way last year).

What About The Technicals?
It’s hard to fault the technicals; as trends go, this one is pretty friendly:

• The moving averages are all pointing skywards, and all lying in the correct order (shortest above longer MAVs).
• The RSI is a healthy 60, though retreating from the overbought level.
• The ADX, trend indicator, shows an encouraging 38 (remember Zebu’s recent piece Finding Trends In Markets said a reading above 20 indicates a trend; the higher the number, the stronger the trend).
• There’s been a steady pattern of higher highs and higher lows over the past few months.

But, but, but, the price has strayed quite a distance from its moving averages (if I could type with more than just 1 finger this might have been published before yesterday’s fall!). Today saw some movement back towards support, but a return to the 21-day MAV ($930) or even the 50-day MAV ($890) wouldn’t be unreasonable, or spoil the bull-run.

A large correction will encourage calls of a double-top, i.e. a second failed attempt to hold the price above $1000, but we’re not there yet.

How Am I Trading This?
While the long term trend looks as hot as a Mexican chilli, I reckon it all got a bit too frothy in the short term. I’ve been short since Friday; I opened my first sell bet at $980, just before the large bout of panic buying. I sold again at $989 and $1002 late on Friday and have shorted the market in the mid $990s over the past couple of days. I’ve closed most of my bets out for small profits, leaving a small underlying short. Betting against a strong trend is pretty rare for me so I certainly didn’t want too much risk on the table.

I’m happy to keep my shorts in place, with a close eye on the equity markets, looking for a test of support at $950. After that I’ll be looking for the 21-day moving average line and, who knows, $900. But at some point, someone remind me to go long!

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