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Gold’s Secular Bull Market Faces Too Much Optimism at Trader’s Narrative

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Gold has the wind at its back right now. Not only has it cleared the challenging $1000 resistance level, it has support from lax monetary policy as central banks around the world clearly hold the health of their economy in higher priority than the health of their budgets or their currencies.

The recent purchase by the central bank of India is being interpreted widely as a vote of strong support for the precious metal. Although I don’t argue against a secular bull market, it is amusing to me that a decision to buy gold at above $1000 is deemed to be a ’smart’ move when just a year ago they could have made the same purchase for 30% less. The fact that almost any news is interpreted as positive for gold has more to do with the prevalent sentiment than with facts.

In any case, before we get to the short term sentiment for gold, here is the recent commentary from David Rosenberg of Gluskin Sheff on the monetary backdrop for a secular bull market in gold:

All India did was bring gold to a 6% share of its total FX reserves from 4%. Fifteen years ago, that representation was closer to 20%. China has increased its gold holdings by 76% over the past six years but they are a mere 1.9% of the aggregate 2.2 trillion of reserves and Russia’s gold holdings is just under 5%. This is not the 1990s when Bob Rubin was running a hard U.S. dollar policy, U.S. fiscal deficits were vanishing and gold production was on the rise. Today’s world is exactly the opposite. Policymakers beginning in the 1990s wanted disinflation and got it. Now they want inflation — it will take years, maybe a decade, but it will come. For the near-term, we are still optimistic on Treasury securities but be forewarned that this view has an expiry date that is earlier than the peak we are likely to see in gold.

It is very clear that central banks are behaving in a way that would suggest that gold is now again being considered a currency within the global monetary system. As we said before, it is all about relative scarcity and a well-defined supply curve — fiat currency at this juncture does not share that quality.

Turning to the breadth in the gold stock sector, you can see that we’ve seen a sudden and dramatic jump from a week ago. The chart below compares the percentage of gold stocks trading above their 10 day moving average with the Philadelphia Gold Bugs index (HUI):

percentage gold stocks above 10 day MA Nov 2009

If you’re interested in timing the gold market, then you would be concerned that 82% of gold stocks are trading above their short term moving average. But you would also be alarmed that just a few days ago, that number was below 10%. Historically, gold shares have a very tough time continuing to climb when faced with such short term headwinds.

Turning to sentiment in the gold sector, on Monday when we looked at the arguments that Paul Tudor Jones II presented for his case of a secular bull market in gold, we also digressed a little to check the Hulbert Gold Sentiment index. That sentiment measure was showing a majority in the bullish camp; which from a contrarian point of view means that gold probably will have difficulty in advancing in the short term.

In a similar vein, here is a chart, courtesy of Elliott Wave, which shows the price of gold with the Daily Sentiment Index (DSI). The most recent DSI is 91% which is just about where previous short term tops have been formed:

EWI gold wave structure daily sentiment index Nov 2009

Similar to the breadth measure (shown earlier) the DSI increased to 91% in a sudden jump (an 8% point jump over a day). Accoding to Elliott Wave, which tracks the DSI, this was the single largest increase since March 19th 2009 (11% point jump from 75% to 86%) when gold made a two month high at $960. With Elliott Wave, not only do you get their analysis of various markets but they do a good job of monitoring DSI, which is a proprietary sentiment metric from and by itself would costs about $2000/year.

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4 Responses to “Gold’s Secular Bull Market Faces Too Much Optimism”  

  1. 1 Mike C

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    Although I don’t argue against a secular bull market, it is amusing to me that a decision to buy gold at above $1000 is deemed to be a ’smart’ move when just a year ago they could have made the same purchase for 30% less.

    I’m not sure exactly what your point here is, or why you would be amused? I’m actually kind of surprised by this comment given that based on my regular reading of this blog, I would think technical trend following is a big component of your decisions (and mine as well).

    So sure…yeah…with the benefit of a 20/20 hindsight crystal ball (I’d be Buffett rich if I had one of those) one should have bought gold 30% lower a year ago. BUT WHAT WAS THE TECHNICAL PICTURE WHEN GOLD WAS 30% LOWER? It had broken below its 200 DMA, the 50 DMA had broken below the 200 DMA (death cross) and the 65 week moving average which had been support going back to 2001 had also been broken. Gold had also taken out some support levels on the move below $700. So all in all, at that time the technical picture looked pretty negative. I’m not even sure you could make the case for mixed.

    So then what? Either you respect the trend or you don’t since you don’t have that crystal ball telling you it is the bottom and it is going to reverse back over $1000 in a year. And…I don’t know…but if there is one lesson….just ONE LESSON I take from 2008 it is don’t try to be a bottom picker (there were stocks trading at prices in Oct 08-Mar 08 that I would have thought were out of the twilight zone or some parallel universe) and simply respect the trend and let the price show you with a preponderance of technical evidence that it has bottomed and the trend reversed.

    So what about the picture now from an intermediate-term to long-term perspective (6 months to next couple of years)? I don’t care about short-term, try to game it or trade it which I think is a losing game (see Jesse Livermore’s rules, catch the major move and ignore the short-term noise and swings). Gold is now above its 200 DMA, the 50 DMA has crossed back above the 200 DMA (golden cross), and most importantly we have decisively taken out and now held (for over a month) a major previous resistance level at $1000-$1034, and continued to make new highs, and I know you know unlike the newbie/novice that buying new highs right after a major consolidation and breakout (NOT after it is already overextended) usually works out well.

    So to summarize all of the above, yeah, I think buying gold at $980 after the consolidating triangle breakout (which is when I re-entered), or after the breakout above $1000, or after the breakout above the March 2008 $1034 high were all much smarter entry points then 30% lower IF one is trying to identify and follow a trend versus bottom pick and hope you are catching the bottom instead of jumping on a downtrend that may yet have long to go.

    I’m all ears and very interested if you have a more detailed argument as to why gold was a smarter buy based on WHAT YOU WOULD HAVE KNOWN at the time rather then benefiting from hindsight bias. I was talking with my Dad yesterday, and he reminded me about how he mentioned the idea of buying Ford at I think it was around $3. And I pointed out that at one time it was a $40 stock, and that if he had been following it the last couple of years would he have bought at $20? More at $15? More at $10? More at $5? He probably would have run out of money to buy anymore by the time it finally fell to $3, and even then he would have had to withstand a drawdown to $1ish before the rebound.

  2. 2 Mike C

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    I would add…that from the intermediate-term to long-term perspective, it will be interesting to see if the Elliott wave guys like Prechter have this right on gold. ALL…and I mean all the other well-regarded market technicians with long-term track records of success and major cred like Louise Yamada and Richard Russell are all long-term bullish on gold. Russell keeps saying he thinks we still have the third speculative, parabolic phase ahead. That said, both Yamada and Russell completely missed the March bottom and Prechter did nail that…but then again one right or wrong call doesn’t guarantee the next outcome.

    In any case, the trend for now is clearly up, and I hope to ride what I think is likely the next big bubble in its infancy. If the trend reverses, I’m out. I’ll exit half on a break below $1000, and the other half on a break below the 200 DMA. If the long-term bull thesis is correct, then we shouldn’t see sub $1000 prices again.

  3. 3 Babak

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    Mike, central banks don’t base their decisions on technical analysis - at least I hope not! - that’s why I said I was amused. But I’m not necessarily criticizing India for not timing gold better. I’m pointing out the response to the news.

  4. 4 grace

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    To chime in on the sentiment front……… for those who follow net assets in the Rydex Precious Metals fund, the figure was 318 as of 11-5-09. There aren’t too many readings above 300 but when there are, there’s usually a pullback in gold. Exception was Sept/Nov 2003.

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