Gold: Technical Correction Before the Final Frontier

Sunday, December 6th, 2009

Gold fell for the first time during last week, off 4% on Friday to $1,162.40 an ounce, the biggest drop since Dec. 1, 2008 after the new U.S. jobs data showed unexpected strength. The Dollar rallied against rival currencies while traders reversed the “Sell Dollar/Buy Gold” strategy. (Fig. 1)

The Dollar’s decline has been a key factor in the record rising gold price this year by boosting the metal’s appeal as an alternative investment along with other commodities and high-yielding currencies.

Though gold briefly touched a low of $1,136.80 during the Thanksgiving week on fears of a possible debt default in Dubai, the precious metal had otherwise continued its vertical ascend into uncharted territory advancing in 21 of the past 23 sessions.

India Leading the Gold Rush

Gold’s rally in the past couple weeks was largely on speculation that India’s central bank may buy more gold from the IMF adding to the 200 ton purchase it made last month.

This second purchase by India would be the fourth central bank sale this quarter of IMF bullion. The three prior sales were Sri Lanka’s $375 million purchase of 10 metric tons; India’s initial $6.7 billion purchase 200 metric tons, and Mauritius bought 2 tons for $71.7 million.

The three sales so far leave about 190 tons up for grabs from the 403.3 tons the IMF announced Sept. 18 it would divest to shore up its finances.

China, The New King of Gold

Private Chinese gold buying, for both jewelry and investment, will overtake Indian demand this year, predicts metals consultancy Gold Fields Mineral Services (GFMS). China is now the world’s No.1 gold mining nation. The People’s Bank is widely thought to have grown its gold reserves by buying domestic production direct.

In addition, China has cut the import tax on jewelry and allowed select commercial banks to sell gold bars, and gold is now traded freely on the Shanghai Gold Exchange.

Russia & Vietnam Not Far Behind

On Nov. 23, Russia’s central bank announced it had bought 15.6 metric tons of gold in October and has said it aims to increase gold’s share in its reserves this year to keep its investments diverse. The Russian central bank had been steadily building its gold stocks this year, which has been up 17% since Jan. 1 to 606.5 tons.

The Vietnamese central bank has also granted quotas to import 10 tons of gold for use by its banking system and gold traders.

Low Interest Rate with Worthless Paper

Some analysts attribute the most recent rally to the reversal of a decades-long selling of gold by developed economy central banks to net buying by emerging market authorities.

Gold accounts for 9% of reserves held by central banks (valued at market prices). Therefore, it is logical for central banks stocking up on gold as it does bring the much needed diversity due to gold’s low correlation with key currencies and its strong inverse correlation with the US Dollar.

However, diversifying reserves primarily via gold rather than other currencies partly suggests the expectation of interest rates around the world to stay low for a long time.  Moreover, it reflects central bankers’ growing distrust of all paper currencies, not just the Dollar.

Surging Derivative Trading

Some of the world’s most successful traders, including John Paulson, David Einhorn, and Paul Tudor Jones, have positions in gold or gold related investments. Pension funds allocate about 5% as protection against the weakening Dollar. Hedge funds and traders are piling into gold futures markets around the world, lured by the record-high prices in the precious metal.

Based on the Commitment of Trader (COT) report as of November 24 by the U.S. Commodity Futures Trading Commission (CFTC), the number of long positions in gold was around 370,000, up about 5,000 from just a week ago, mostly from non-commercial short-term speculative investors.

It is also interesting to note CFTC Nov. 2009 monthly report shows that while commercial participants held net short positions; non-commercial and other participants, who accounted for 51.4% of open interest, held net long positions,. Some traders already indicated there has been some good upside buying in March and April in the $1,300s and even $1,400s.

Overall, NYMEX Gold futures open interest increased 4.8% in November with longs outnumbering the shorts by 71% to 12%. This would have been the highest number of long speculators in the history of the New York gold market since 1975, except for last year when the gold hit $1,030. (Fig. 2)

High number of speculative positions is the driving force of the commodities rally in general, but that also makes gold vulnerable to further corrections as well as high volatility.

Diminishing Physical Demand

Regardless of the gold fever this year, according to the third quarter 2009 Gold Demand Trends Report from the World Gold Council, demand reached 800.3 tons, representing a drop of 34% year-over-year. The report also found that average gold prices for the quarter were 10% higher than in the same quarter last year.

Diminishing physical demand coupled with higher price suggests it has been mostly speculators that are driving up the price. In addition to central banks using gold to rid Dollar dependency, fund managers and speculators also have been driving up the price of gold, partly seeking protection from potential inflation in a low interest rate environment.

Fear Factor

Gold is a commodity that perception plays a more significant role than other market factors. Almost all other commodities such as crude oil, natural gas, copper, prices often fluctuate on indications of inventory, supply, and demand; whereas gold moves primarily with investor’s fear or perception of inflation, U.S. Dollar and the economy.

But just as fast as the market perception can drive prices straight up, it could tank an asset class in a matter of minutes. As discussed here, investment/speculator demand is clearly a major factor in the current gold price rally, a decline could potentially take the gold price down quite significantly on indications such as rising interest rate, or the U. S. Dollar starts to strengthen.

If history is any indication, after gold rose sharply in 1979-1980 to $850, it was followed by a drop to near $500 in less than 2 months. It is conceivable that gold could take a similar loss in a short time.

Short-term Outlook

The general expectation is that the Federal Reserve will not act in favor of the Dollar until later next year. Gold and Dollar correlation is still highly negative, but one should expect a fair amount of volatility given the uncertainty of global economic direction intensified by the Dubai crisis. In that sense, gold could certainly challenge the $1,225 levels again, with $1080, $1050 and $1025 each represents significant support level.

Technically Overbought

Friday’s pullback has moved gold’s MACD to the downside and the 14-day Relative Strength Index (RSI) back in the neutral territory (Fig. 1), which could spur more selling if Dollar retains its strength.

Though gold’s longest rally (nine days) since 1982 ended last Wednesday, the precious metal is racking up a near 35% gain on the year, and moved up almost 17% this month alone, heading for the sharpest annual increase in two decades.

So, at this level, gold has also run into profit-taking, as well as year-end fund manager’s portfolio repositioning. Closes below the 20-day moving average crossing would likely confirm that a short-term top has been posted.

Long Term Bullish Intact

Sporadic green shoots of economic data could obscure the harsh reality, and lead to gold weakness in the short term. Nevertheless, there’s enough momentum around for gold to make new highs as long as the Dollar stays weak spurring further safe haven demand on concerns about a double dip recession.

Therefore, the potential exists for a large rise in the longer term. However, if this rally extends into uncharted water on momentum without a healthy enough correction, upside targets will be hard to project with the eventual correction equally difficult to predict, just as they say, “The higher you climb, the harder you fall.”

Economist Forecasts & Opinions

Tags: Alternative Investment, Bullion, Buy Gold, Central Banks, China, Chinese Gold, Commodities, Debt Default, Emerging Markets, Final Frontier, Gold, Gold Fields, Gold Mining, Gold Price, Gold Reserves, Gold Rush, India, Investment Funds, Metric Tons, Mineral Services, oil, Precious Metal, Prior Sales, S Central, Uncharted Territory, Unexpected Strength
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Byron Wien: Ten Surprises for 2009

Tuesday, January 6th, 2009

Byron R. Wien, Chief Investment Strategist of Pequot Capital Management, Inc., today issued his list of Ten Surprises for 2009. Mr. Wien has issued his economic, financial market and political surprises annually since 1986. The 2009 list follows:

1. The Standard and Poor’s 500 rises to 1200. In anticipation of a second-half recovery in the U.S. economy, the market improves from a base of investor despondency and hedge fund and mutual fund withdrawals. The mantra changes from “fortunes have been lost” to “fortunes can still be made.” Higher quality corporate bonds, leveraged loans and mortgages lead the way.

2. Gold rises to $1,200 per ounce. Heavy buying by Middle Eastern investors and a worldwide disenchantment with paper currencies drive the price of precious metals higher. In a time of uncertainty, investors want something they can count on as real.

3. The price of oil returns to $80 per barrel. Production disappointments and rising Asian demand create an unfavorable supply/demand balance. Other commodities also rise, some doubling from their 2008 lows. Natural gas goes to $9 per mcf.

4. Low Treasury interest rates coupled with huge borrowing by the Treasury send the dollar into a serious downward slide. Overseas investors become concerned that the currency printing presses will never stop. The yen goes to 75 and the euro to 1.65.

5. The ten-year U.S. Treasury yield climbs to 4%. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.

6. China’s growth exceeds 7% and its stock market revives. World leaders credit China’s authoritarian government for its thoughtful stimulus policies and effective execution during a challenging period. The Chinese consumer begins to spend more and save less and this shift is behind the unexpected strength in the economy.

7. Falling tax revenues from the financial sector cause New York State to threaten bankruptcy and other states and municipalities follow. The Federal government is forced to step in and provide substantial assistance. The New York Post screams “When will the bailouts stop?”

8. Housing starts reach bottom ahead of schedule in the fall, and house prices stabilize after dropping 15% from year-end 2008 levels. The Obama stimulus program proves effective and a slow growth recovery begins before year-end. Third and fourth quarter real gross domestic product numbers are positive.

9. The savings rate in the United States fails to improve beyond 3%, as most economists expect. The concept of thrift seems to have vanished from American culture. Peak job insecurity and negative growth drive increased savings early in the year, but spending resumes as the economic growth turns positive in the second half, making Christmas 2009 the best ever.

10. Citing concerns about Iraq’s fragile democratically elected government and the danger of a Taliban-controlled Afghanistan, Barack Obama slows his plan for troop withdrawal in the former and meaningfully increases U.S. military presence in the latter. In a hawkish speech he states that the threat of terrorism forces the United States to maintain a strong military force in this strategic area.

Mr. Wien believes these surprises, which the consensus would assign only a one-in-three chance of happening, have at least a 50% probability of occurring at some point during the year. In previous years, more than half of the elements of the list have proven correct.

Pequot Capital Management is a private investment firm.

Source: Business Wire
http://www.businesswire.com/portal/site/home/permalink/?ndmViewId=news_view&newsId=20090105005763&newsLang=en

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