Could Gold Soon Go Ballistic?

The price of gold is at present widely expected to correct – this expectation is based on the fact that it looks rather overbought at the moment, see below:

 


 

The price of gold in dollar terms – it certainly looks short term overbought – click for higher resolution.

 


 

Some gold bears,  like analyst Dean Junkans from Wells Fargo, once again believe that they have spotted a 'bubble' destined to burst at any moment, see this Reuters article.

As far as we can tell, he uses the same old tired argument we have heard a thousand times on the way up, namely a spiel on the 'crowded trade' idea and the equally misguided idea that gold can only rise if 'the end of the world' is here. This probably shouldn't even be dignified with a response, but let us just say that if you were to ask a room full of investment professionals who has an investment in gold, it wouldn't take you much longer than five seconds to count the hands that go up.

Gold bulls generally also expect a correction in the near to medium term (as far as we can tell from anecdotal evidence), on account of the large and uninterrupted rally from the previous consolidation area.

We have a different observation here that we would like to share – and mind, this is not a forecast,  we are merely sharing something that is a matter of experience. Gold and commodities work in the exact opposite manner to stocks. They bottom gradually and make spike tops, whereas stocks tend to make spike lows and usually top out gradually. The reason for this difference in behavior is that the same emotion that drives rising commodity prices also drives falling stock prices: fear.

In stocks we often observe that when the market is very oversold but fails to bounce in spite of that condition, a crash or a mini-crash can happen – as was in fact recently demonstrated. The opposite can happen in gold and commodities –  an overbought condition can lead to an upside blow-off.

We note that the gold market has been overbought for quite some time, but so far has refused to correct. Of course a short term correction remains the higher probability bet, however, one must be alive to the possibility that the recent persistent overbought state could also be the precursor to a blow-off move.

Recall for instance what happened with silver late last year and early this year  – from the point where it exhibited a strong and persistent overbought condition for the first time, it proceeded to almost double in price following a very brief, but hefty shake-out. Again, we are not predicting that the same will happen with gold here and now. We can not know that, and it is the lower probability outcome as mentioned above, but the fact that gold has remained persistently overbought for over three weeks now is a hint that something unexpected could happen.

 

The Charts

Below is our usual collection of charts of CDS, bond yields, euro basis swaps and a few others. While there are many spreads and yields that have come in a bit, there is still plenty of evidence of financial stress. Prices in basis points, color-coded where applicable. Here one can see where the potential trigger for a blow-off move in gold could originate.

 


 

5 year CDS on Portugal, Italy, Greece and Spain – a slight bounce  is in train – click for higher resolution.

 


 

5 year CDS on Ireland, France, Belgium and Japan – click for higher resolution.

 


 

5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for higher resolution.

 


 

5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click for higher resolution.

 


 

5 year CDS on Romania, Poland, Slovakia and Estonia – click for higher resolution.

 


 

5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – click for higher resolution.

 


 

5 year CDS on Germany and the US (the scale has been adjusted so they have the same starting point – see the price multipliers indicated in the legend) – click for higher resolution.

 


 

Euro basis swaps (3 months, one year, five years) – bouncing, but not by much – click for higher resolution.

 


 

5 year CDS on the 'Big Four' Australian banks – a pullback is in train, but it's not much of one yet – click for higher resolution.

 


 

10 year government bond yields of Ireland, Greece, Portugal and Spain – everything except Spain is in bounce mode (as the ECB is currently primarily intervening in Spanish and Italian bonds) – click for higher resolution.

 


 

10 year government bond yields of Italy and Austria, UK gilts and the Greek 2 year note – the 'safe haven' yields continue to collapse to new lows, while Italian bonds are  supported by the ECB. Unsupported Greek debt is selling off again – click for higher resolution.

 


 

Inflation-adjusted yields keep heading down (inflation expectations are falling) – click for higher resolution.

 


 

L.A. inbound containers – this is a very weak reading for this time of the year – click for higher resolution.

  


 

The Markit SovX index of CDS on 19 Western European sovereigns – pulling back a bit, but this remains a bullish chart in our opinion. We ergo expect the crisis to soon flare up again – click for higher resolution.

 


 

The HSBC 'Financial Clog Index' – the TED Spread, LIBOR-OIS, Financial CDS Spreads, Agency Mortgage Credit Spreads and the VIX, all equal weighted in one index – click for higher resolution.

  


 

Lastly, the Wilderhill Clean Energy Index – as our friend B.C. remarked today: “leaving investors clean out of money with the least amount of energy expended” – click for higher resolution.

 


 

 

Charts by: Bloomberg, StockCharts.com


 

 

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11 Responses to “A Few Remarks on Gold and a Chart Update”

  • swaper:

    Peter,
    Thanks again for the fantastic blog site. Your insights are original and prescient. Your comment on Gold ” Gold has a peculiar characteristic: in times of growing economic uncertainty and during recession , its price tenet to rise against the prices of all other goods..only form of money supply of which can not be increased..the demand for money tends to increase in times of declining..” I had always thought that while the above is correct, Gold would underperform in a recession because of the de-flationary aspect of economic contraction.

    • Economic contractions are not necessarily deflationary, otherwise the ‘stagflation’ of the 1970’s and the hyper-inflation of Zimbabwe could never have happened. If you think about it, in a recession FEWER goods and services are produced, while the central bank prints MORE money concurrently. So two of the aspects of what Mises called the ‘money relation’ are actually harboring INflationary effects during a recession. On the other hand, there is often a sharp increase in the demand for money (cash holdings) and the urge to repay outstanding debts which both exert a deflationary pull during recessions.
      Gold has in the period from 2000 to today tended to correlate most closely with the actual increase of the true money supply rather than the government’s CPI data, so as long as the Fed keeps pumping up the money supply, gold’s nominal price should remain firm even during recessions (its REAL price ALWAYS rises during economic contractions).
      Note that jewellery demand and mine supply play a very minor – in face negligible – role in determining the price of gold.
      Today gold is also reflecting the fear of market participants that the monetary and fiscal authorities are losing control over the monstrous fiat money system we have had in place for four decades now. It is delivering a verdict on its likely failure.

  • Floyd:

    Thanks for sharing your thoughts, Pater.
    The 2008 30% plunge in gold caught me by surprise.
    Is it plausible that we will witness similar price action this time yet again?

    (Consider the graph here http://jugglingdynamite.com/2011/08/18/c-breaks-down-will-gold-follow-again-this-time-as-it-did-in-08/ ).

    • I doubt it, because when the 2008 crisis struck, true money supply growth had been very weak for over 2 years already. By contrast we are currently in a period of rapid money supply growth that has been in place for the past 36 months without interruption.

  • amun1:

    The “gold bubble” is not going to burst unless the sovereign debt bubble bursts first. How do the analysts justify momo stocks up 500% in two and a half years, while the 10 year treasury hits an all time low yield? Is that the new goldilocks? I don’t think so.

    When the gold bubble popped back in 1980, do these guys remember what ended that bubble? Here’s a hint; it wasn’t QE or ZIRP.

    • Exactly – it took an FF rate of over 20% and a genuine contraction of the true money supply (year-on-year) to stop gold’s ascent in 1980 – by contrast we are stuck with ZIRP for at least two more years today.

  • hedy1234:

    It will easy for Gold to be pushed down. They will merely raise the margin requirements like they have for silver. This has been done 7 times so far I believe.

    • amun1:

      There’s a problem with that strategy and the Comex knows it. Those futures markets are only attractive because of leverage. The less of it they allow, the more potential gold buyers are pushed towards physical. If they push the price down sharply in opposition to the fundamentals, while reducing the available leverage, at some point you’ll get a run on the Comex and they’ll default to cash delivery. When that happens, the futures markets will be in disarray and useless as a market control mechanism.

    • I wrote this last night, and so far, so good. I agree with you though that COMEX will hike margin requirements and eventually this could help to push gold lower again. But in a blow-off move we should see it go markedly higher BEFORE the margin hikes have this effect. Don’t forget, the shorts are ALSO subject to higher margins, and the longs have a buffer due to the gains they have already in their accounts. So it is the shorts that will be under more pressure when margins are hiked, at least initially. That is also why in the final stages of blow-off rallies you usually see the shorts capitulating.

      • hedy1234:

        Remember when silver got to $50 there was an immediate 30% “correction”. For gold this would move it back to $1300……

        Even if the correction is only 15% it would back down to $1530 before it moves back up. I would say there is a 50/50 chance that this would happen to scare out all the folks that came to the gold party late.

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