Commodities | May 20 2010
By Greg Peel
Every financial market undergoes periods of overbought euphoria and oversold fear, such is the nature of human behaviour. Gold is no exception, albeit in gold's case one might argue it is fear that drives gold higher and euphoria that sees it wane. As the following chart shows, the last five years have seen several “blow-off tops” in gold followed by quick retractions.
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It's been a bit of a case of “two steps forward and one step back” for gold during the entire rally from US$250/oz to US$1200/oz. The rally in general is one based on the secular devaluation of the US dollar over the period, which itself is representative of the parabolic increase in US debt and a growing distrust of fiat currencies (with the euro now the main target). Adding to demand has been Emerging Asia's increasing capacity to buy jewellery, and the introduction of financial instruments such as exchange-traded funds (ETF), which has opened up the gold market to a much greater population of investors.
It might be a valid argument that gold has become the financial asset most likely to suffer from temporary bubbles, such is the historical relationship between man and the most coveted of all metals. When buying momentum builds from the financial markets, retail buyers come barreling over the top, and suddenly every taxi driver is talking about the gold he bought.
On the other hand, there have been recent periods in which gold has been sold in seeming defiance of its “safe haven” perception. One such period was following the fall of Lehman Bros when gold was immediately trashed. While that fall brought the rest of the world into what was now a GFC rather than just an American financial crisis, and as such the US dollar rallied, one might have expected that the extraordinary jump in global fear would have meant gold was the obvious place to run to and hide. But the problem was the amount of stocks being held on margined credit, and the subsequent margin calls flowing from the stock market's demise. Cash-strapped investors had to sell something to cover their margins, and so they sold gold.
But secular gold investors enjoy such periods, because it means they can pick up more of the metal “cheaply”. And here we are, having just broken price records again.
While the comparisons to the GFC and the current European crisis are obvious, this time there has been no gold selling as stock markets have tanked. There are likely two reasons for this: (1) there are not nearly as many stock market investments backed by dangerous credit levels since the GFC lesson was learnt, and (2) this time we have a sovereign crisis, not a corporate crisis, which feeds more directly into fiat currency fears.
But having made a very rapid run from US$1100/oz in late March to break the previous US$1230 record set in in November (when India was buying IMF gold and Dubai was a precursor to Greece), gold suddenly stalled. In short, gold had bubbled, driven once again by a wave of retail interest.
As Dennis Gartman puts it, “the 'spec' public is hugely long of gold and will be washed out”.
Gartman was writing prior to last night's US$30 fall in gold, which smacked of panic. Realistically, the stall in gold's run had “consolidation coming” written all over it. The “last man in” to the gold trade was expecting gold to keep rallying, but it didn't. So he panicked and sold.
Once again, secular gold buyers, of which Gartman is one on a longer term horizon (he is also a short-term trader who jumps in and out when appropriate), love these sell-offs. It makes gold cheaper.
The wash-out of the “spec” public, notes Gartman, will “make the market healthy again, but at lower rather than higher prices. We can readily imagine seeing spot gold in US dollar terms trading back toward US$1175-1185/oz and doing absolutely nothing to the efficacy of the long-term bull move in gold's favour”. Last night gold traded down to US$1191.40/oz.
The stall in the price of gold, apart from the bubble effect, can be contributed to the amount of money the EU intends to throw at the euro to stabilise the common currency and an expectation that the euro might rally as a result. It hasn't yet, but it might from a lower level. Realistically, the latest run-up in gold has been all about the euro. Gold has rallied in US dollar terms even as the US dollar has rallied (and fell last night as the dollar fell) because of the sheer weight of demand coming out of Europe, aside from the US.
Gold may even yet fall further than Gartman suggests, perhaps back to under US$1150/oz or so if the euro can indeed hold steady, but the fact remains analysts across the world are now in a process of upgrading their 2010 and 2011 average gold price forecasts. Many see US$1350/oz ahead.
The good news for Australian gold investors however, is that US dollar gold has rallied even as the US dollar has rallied, which means Aussie dollar gold has rallied even further as the Aussie dollar has fallen. Don't take such activity as a given, because any long-term Aussie gold investor will warn you it can easily work the other way as well. But in the period of gold's rally from US$1100 to US$1230/oz, it has also rallied from A$1200 to A$1380/oz.
The message here is that in periods of global uncertainty, gold is ultimately a handy asset to have as part of a balanced portfolio. Gartman, and others, will also suggest that in a period in which major global currencies are weighed down by debt, gold is the “other” reserve currency.