What We Like & Don’t Like About Gold

Whenever a sharp and unexpected correction occurs after many years of gains, one is forced to take a step back and consider whether the bull market has breathed its last. Frankly, we don’t think it has, but the best way to go about this exercise is to consider legitimate bearish arguments. Words: 1853

So writes Peter Tenebrarum (www.acting-man.com) in edited excerpts from his original article* entitled Gold – What We Like and What We Don’t Like. 

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The article may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read.

Please note that these paragraphs must be included in any article re-posting to avoid copyright infringement.

Tenebrarum goes on to say in further edited excerpts:

Bearish Technical Arguments

Regarding the market’s technical condition, there are a number of more or less obvious problems:

1. Gold mining stocks – which have led the decline – continue to fail to show signs of life, never mind putting in a convincing reversal. Maybe that will have changed by the time you read these words, but as of Wednesday’s close the carnage in the sector has continued without even a pause. Given that the gold stocks have led the decline, we must assume that they will very likely also signal the turn and lead the next advance. Any failure to do so should be viewed with suspicion (if e.g. the stocks were reluctantly ‘dragged up’ by a rising gold price, we would consider that a bearish omen at this juncture).

2. Gold has broken through a lateral support line that has held for many months isn’t a good thing either. It means this support will now act as resistance (at least we do have that information now)…

3. The temporal distance between the April 2011 top in silver vs. the November 2011 top in gold is a ‘double divergence’ – first gold didn’t confirm silver’s new high, then silver didn’t confirm gold’s.

We have observed such double non-confirmations at the bear market lows in the late 90’s/early 2000ds as well and, at the time, we felt that this was one more piece of evidence arguing in favor of the idea that a major secular low was being put in place by the precious metals. We can therefore not simply gloss over the fact that the opposite has just happened in 2011. Of course there are also good fundamental reasons for why silver did better at first and gold did better a few months later. It may yet turn out that this particular divergence was not  meaningful with respect to the long term bull market, but was only of medium term significance. However, it nevertheless remains a concern.

As an aside to the above, gold stocks too have produced such divergences with the metals, both at the long term lows of 1999-2000 and the highs of 2011. One cannot simply dismiss these technical warning signs out of hand at this point.

Bearish Fundamental Arguments

We have already highlighted what we believe to be a major underlying theme (namely growing, if misguided, ‘deflation’ fears) behind the recent sell-off. However, …an additional point that we neglected to mention in our previous missive…[is that] one day before the massive sell-off last Friday, President Obama signed the new ‘sequester’ for the next fiscal year, amounting to $109 billion…[and] he has also ended the two costly legacy wars of the Bush administration…As a result, there is thus a genuine chance that the budget deficit will shrink noticeably in coming years and this tends to be somewhat  bearish for gold – it always has been. The reason is that the U.S. dollar is gold’s major antagonist in the currency universe. It has replaced gold as the major foreign central bank reserve asset after the 1971 Nixon gold default. Thus a sharply rising US public debt and rising deficits have traditionally been regarded as bullish factors for gold, and conversely, shrinking deficits are deemed to be a bearish factor.

We recommend therefore to keep a close eye on how the deficit develops from here. A renewed economic downturn would of course see it explode again, sequester or no sequester.

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What We Like – A Few Bullish Data Points

1. Technically we like that the recent selling squall occurred on such huge trading volume…Such extremely high trading volume is rarely encountered at the beginning of a bear market – rather it usually indicates a climactic panic. Of course we have no historical basis that could tell us what a ‘climactic panic’ really should look like nowadays. Perhaps it requires even higher volume.

2. We continue to like the sentiment backdrop. An absolutely amazing flood of anti-gold vitriol has been spewing forth in the media in recent days, in many cases penned by people who demonstrably know absolutely nothing about gold, mostly Keynesian gold haters from the statolatry faction. Not one of them ever told people to buy gold at the lows of course, or at any point on the way up – but they sure all just know now that the bull market is over!

The media blitz looks almost orchestrated. Sell-side analysts have been harping about gold’s weakness for several weeks already. This culminated in the Goldman Sachs call to go short gold, which was given rather unusual prominence in the media as well. Normally the press doesn’t engage in such extensive reportage every time Goldman issues a market call (which is actually a good thing, as these calls are as a rule not much better than flipping a coin).

Admittedly we were  surprised by the breakdown (we wrongly assumed the support line would continue to hold), as were many of those whose gold related opinions we actually value. However, it should be clear that markets can surprise just about everyone from time to time (in fact, it happens quite often). One’s knowledge about the gold market is not necessarily dependent on getting every forecast right. Indeed, forecasts are of little value in the short term anyway – way too many things can potentially derail them. At best one can gauge probabilities, which then need to be continually reassessed in light of the actual market action.

However, the recent flood of nonsense sweeping the press (which often reads like a not very sophisticated anti-gold promotion aiming to bring home the point that ‘gold is a bad investment’) is quite a sight to see. We didn’t know that so many people apparently just hate gold. Anyway, all of this has further solidified the already very bearish sentiment backdrop. While that has not helped the market so far, it will be very helpful when this surfeit of bearish sentiment finally unwinds in the next rally.

As an aside, many of the so-called ‘experts’ are groping in the dark as well, to put it mildly….Morgan Stanley, for example, says that it sees [these supposed] ‘four pillars’ of the gold bull market crumbling:

1. Rising investment demand through ETFs,
2. Controlled central bank selling and significant buying by emerging market central banks,
3. Gold buy-backs (we assume this refers to hedge books) and
4. Weak mine supply growth. (comment in parentheses ours)

The above is what the gold analysts of one of the world’s biggest investment banks believe drives the gold price. We think this is downright embarrassing, but there it is. This is what actually passes for thoughtful ‘expert’ gold analysis nowadays. Evidently the opposition is coming to the fight unarmed.

3. The additional surge in bearish sentiment this recent flood of negativity has produced is mirrored in various survey data – and here we can see potentially positive divergences:

a) Gold, public opinion. This is an example of a bullish divergence: more bearishness at a higher price level than in 2008, and amid a correction of similar size (in percentage terms).

b) Silver, public opinion – we see the same thing here – lower levels of bullishness at a higher price and amid a decline that is roughly similar in percentage terms as that of 2008.

It should be noted that most of the people who insist now that the bull market is over, not only never saw the bull market coming in the first place, but have told us on several previous occasions already that it was over. Anyone who shorted gold when arch-Keynesian Nouriel Roubini first declared his bearishness would have been carried out on a stretcher a long time ago and would still be massively underwater even after the recent crash-like rout.

Even many of the arguments sound very similar as last time around. There is for instance this one: there is a crisis and gold fails to rise in the face of it – this must be bearish. The same was said in 2008 over and over again, and it has repeated recently mainly in the context of Cyprus. In reality, gold rarely does what it allegedly ‘should’ be doing according to various theories. However, it does have a tendency to discount massive money printing and rising fiscal deficits. Various leads and lags are involved that generally follow no fixed pattern. In hindsight it appears as though it has probably gone too far too fast in 2011.

4. This brings us to the fundamental bullish case:…the money printing efforts by central banks are doomed, as they will produce exactly the opposite outcome in the long term as that intended. Moreover, the reaction of the monetary authorities to this failure will be to do more of the same, i.e., to print money on n even greater scale.

The evidence pointing to such an outcome is extremely strong at present. The first half of the thesis is based on sound economic reasoning, the second half on observations of the behavior and statements by central bankers up until recently.

It is always possible that we will need to revise this assessment at a later date. We cannot make definite pronouncements on the unknown states of knowledge of an unknown future. However, given that we are dealing with probabilities, we can definitely state that this particular case is one that, without a doubt, favors the bulls. After all, today’s central banks are essentially pursuing the same basic strategies that were pursued by people like John Law, the revolutionary assembly of France and many others who sought to ‘revive the economy’ by flooding it with additional money only they are, of course, going about it in a so much more ‘scientific’ manner today that nothing can possibly go wrong. It is precisely this hubris that ensures that more of the same is in the offing.

Conclusion:

We certainly don’t know what the old market will do in the short to medium term. There are as usual both bearish and bullish data points one needs to consider. However, we can make a few educated guesses as to what is required to restore the bullish trend, and what would likely argue in favor of a continued bearish trend.

• In the short term we would closely watch the action in gold stocks relative to gold.
• In the medium term, developments on the inflation/deflation front and government’s debt and deficits must be monitored.
• Technically, gold would now need to overcome stiff resistance at the former support line in the $1525-1540 region. Support is provided by the previously discussed $1300 and $1040 levels (a few more minor support levels lie between those two).

The sentiment backdrop continues to suggest that the decline is a major correction in a secular bull market…

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

*http://www.acting-man.com/?p=22773 (Copyright © 2008-2013 acting-man.com – All rights reserved)

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