Is Gold Last Year’s Fashion?

In little over a month, gold has gone from the ‘must have’ investment accessory to last year’s fashion. What caused this fall from grace and is it ready to make a comeback?

Back in February, King Midas was top dog in the investment world. As equities collapsed, gold stuck a big toe through the $1000 mark and was widely tipped to make a record high.

But with equity markets rising by around 20% during March the precious metal lost its appeal (a question we asked in February’s Has Gold Lost Its Shine?). At Monday’s close gold had fallen by $142 (14%), breaking below its trendline support.

Here’s a quick look at what caused the fall and a few factors to take into account before placing your bet on the next move.

What Caused The Fall?

We’ve been here before so just to re-cap, the movement in gold prices is broadly influenced by:
1) The rise or fall of the US Dollar
2) Inflation expectations
3) Risk Aversion (financial or geo-political)

For me the blame lies squarely on No3, oh and a No 4 (supply and demand-see below). I’ve not noticed any correlation with moves in the Dollar and, if anything, recent inflation data has come out slightly above expectations.

Firstly, gold was due a setback after its 20% rise in a month. The necessary pullback then coincided with a return of risk appetite as equities put in double-digit gains. Gold’s safe-haven status dwindled just after prospectors had filled their boots, leaving the market to fall until it found the next level of demand. The record inflows into gold ETFs dried up as investors found more appeal in riskier markets.

Supply And Demand

Following G20 the IMF took quite a bit of stick over speculation that it was going to dump bullion on the market to bolster its finances, but this was soon dismissed by gold specialists. And if anything, sales by central banks were expected to be well below permitted levels this year.

Two far more relevant factors have been weak demand in the jewellery market and surging supplies of scrap. Global demand for jewellery fell by over 10% in 2008 and this trend carried on into the first quarter of this year. Global scrap supplies rose by 27% in 2008, and this continued into the early part of 2009. Higher gold prices and the economic downtown led to gangster rappers selling their teeth, and a lot of industrial recycling in the Middle East and Asia.

Gold, priced in Indian Rupees was much higher than in Dollar terms; this had a dramatic effect with the world’s largest consumer of bling not importing at all during February and March, and even rumoured to be selling the precious metal.

Relative Value

A lot of traders and hedge funds look at the price of gold relative to oil. This reached its most extreme position for over a decade in February and hasn’t recovered much since.

Comparisons with copper and platinum are similar, suggesting that gold is extremely overvalued against several other commodities. This could explain some of the recent rise in the oil price as traders and hedge funds play the short gold/long oil bet.

Seasonal Factors

If we re-visit the chart, kindly provided by Dimiti Speck from seasonalcharts.com March ran pretty much to form, selling off from February’s highs.

The chart, which shows the seasonal pattern of gold over 37 years, suggests a slight rise during April before demand hits the after-burners in May. No guarantees, but worth bearing in mind.

Technicals

The price (currently $882) is in a critical area, perched on the 100-day moving average. The 21-day moving average (my trend indicator) is pointing down the mines and an RSI of 38 doesn’t offer much hope. An ADX reading of 26 confirms the downward trend, as does the candle pattern.

Normally Wednesday’s Doji candle would suggest indecision before a possible reversal. I’m tempted to think it was down to a lack of trade ahead of Easter, but holding the 100-day MAV is key.

On the upside gold needs to poke its head above $890 to arouse interest and $900 to put the bulls on red alert. Traders will then look for the price to break and hold the 21-day MAV at closer to $915.

Outlook

Views here are widespread to say the least. The calls for $1000 plus are still there, with forecasts of $2000 over the next 5 years. Few argue with those levels over the longer term, but whilst some experts advocate loading up now, others are looking for $800, or even lower, over the next few months.

At the moment focus is on avoiding deflation, but stimulatory measures are more like ocean liners than a jet skis; they can’t turn quickly and therefore won’t react in time when prices stop falling. The big fear is that governments are emulating Mary Shelley and creating something which will one day be uncontrollable.

It needn’t be actual inflation that re-ignites demand for gold; just the fear of its return. Investors might get spooked by further helicopter drops or some evidence of a turn around in producer prices.

In the near term, gold’s safe haven status is dependent on whether we believe that the economic worst is behind us and that we’re entering a long flat period of subdued growth; signs that shares are due another painful leg down will see investors rushing for the bullion vaults.

How Am I Trading It?

I’m bullish of gold in the long term, whether as a safe haven or a hedge against inflationary government policies (perceived or real). But the technicals are lousy, so is the value against comparative commodities.

In the short term I have a bias towards shorting, but first I want to see a fresh break below the 100-day MAV at $880. If we see that, I’ll target the 200-day MAV at around $865 and if that level blows then full steam ahead for $800.

If the 100-day MAV holds, then I’ll look for a confirmed push above $890 before getting involved on the buy side.

The big question, of course, is the fate of shares. If the equity sell-off continues, breaking trend line support, then I’ll look to load up on bling.

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