Thursday, December 15, 2011

Gold Breaks Down, Where to Look for a Bottom

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Gold fell and closed below its 200-day moving average yesterday, December 14th. This indicates a technical breakdown and the last time this happened was in August 2008. Gold bottomed approximately 30% off its high three months later in November.

Any analysis of an investment's technical state should begin with the big picture, so recent events can be put in context. Gold is in a secular (long-term) bull market which will last until approximately 2020. This means that the greater trend will move prices higher over time. No market moves straight up however. There are always reversals in a secular bull market and these are sometimes steep. The 1987 stock market crash which took the U.S. indices down 40% and some individual stocks down 70% or even 80% took place in a secular bull market that lasted between 1982 and 2000. Stock prices went to new highs after the crash despite many pundits claiming the crash meant a new depression was coming. Anyone who realized stocks were in a secular bull market could easily have predicted stocks would recover.

Even though gold has dropped below its 200-day (40-week) simple moving average, this does not indicate that it is even in a short-term bear market. At the very least the 50-day (10-week) moving average would have to fall below the 200-day to indicate that. Gold will have to trade below it's 200-day for approximately the next two weeks before that would happen. This did indeed occur in 2008, when it could be said that gold experienced a brief cyclical (short-term) bear market.  The 10-week moving average traded below the 40-week for about four months from September 2008 to January 2009. See a four-year weekly chart of the Gold ETF GLD below.



The bearish behavior of gold in latter 2008 was caused by the Credit Crisis. While you have probably heard ad nauseum that gold is a safe haven in a crisis, this does not include credit crises
(which are crises in the financial system when the banking system has difficulty functioning). We just saw that gold went down during the 2008 credit crisis and yet many gold "experts" somehow can't figure out that it should go down during the current 2011 credit crisis coming out of Europe. In our era, gold can drop during a credit crisis because central banks lease gold at low rates to the big banks and hedge funds. These entities are desperate to raise cash, so they sell the gold into the market (they can't sell many of the assets on their books). This depresses the price of gold -- temporarily. But at some point, they have to buy the gold back and return it to the central bank it was leased from. This makes the price of gold rise again. I explained the entire process in the second volume of my book "Inflation Investing", which covers gold, silver and other metals.

Gold has support at the 65-week simple moving average, but this is not the likely bottom in a full-blown credit crisis.  In order to find that, it is necessary to look at a monthly chart. It can be seen from this that the ultimate support would be at the 40-month simple moving average. Currently, this is around 120 for the gold ETF GLD. This possible buy point, which should be considered a worst-case scenario, was discussed in the October meeting of the New York Investing meetup. See the five-year monthly chart for GLD below.




It's important for investors to focus on the big picture and not get carried away with all the distractions of day to day price movements. Markets go up and down. No market goes in one direction. Every time gold drops, commentators come out of the woodwork saying it means the rally is over and deflation is taking place -- neither is true. It is the bigger price movements that have meaning and gold is in a long-term uptrend. In any secular bull market, a large drop is always a golden opportunity to buy. Just wait until there is some evidence that a bottom has been put in.  

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York
Investing meetup http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

21 comments:

Donnie Miller said...

Thank you for the article. Besides GLD nearing 120, what are some other signals that will indicate a bottom?

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