Trader’s Narrative

Not surprising after the extremely negative sentiment in the US dollar index, the greenback has staged a modest rally. In response, gold has wilted. Here are few perspectives on what may be next for the precious metal:

Elliott Wave International
Arguing for the bearish case, is Robert Prechter of Elliott Wave International. He writes that since 1913, as shown in the chart below, the purchasing power of the US dollar has eroded by 96% (great job Fed!). If gold had simply offset this loss in purchasing power, it would have to have increased 25 times. But instead gold has multiplied in value by 50 times. Therefore, Prechter argues, it is 50% ‘overvalued’.

This is a strange sort of argument because most gold bugs would say that gold’s strength, the very fact that it has gone up so much, reflects positively on the precious metal. Prechter has had a very hot hand lately in timing the stock market so I’m willing to listen to his argument even if it sounds a bit odd. It appears that he implies that gold’s only sensible ‘value’ is to be the anti-dollar. However, I’m not sure that’s a valid point because as far as I’m concerned, gold is just another commodity with all the inherent susceptibilities to manias and panics we ascribe to other more traditional markets like stocks.

While I’m reticent to embrace this line of thinking, I do agree with something else that Prechter wrote recently about gold:
Continue reading ‘What’s Next For The Gold Bull?’

Proving the old technical analysis adage true that the more a level is attacked, the higher the probability that it will break, gold recently broke through the $1000 ceiling and closed at a new, all time historically high price.

While this got a lot of attention in the media, gold sentiment remains relatively subdued in response. Since gold is the haven sought by dollar bears, the big question is whether this important technical move is a result of weakness on the part of the US dollar or whether it is secular strength from the gold market pure and simple.

The simple way we can look at this question is to strip away the effect of the US dollar by dividing the price of gold by the US Dollar Index, as the chart below shows:

With US dollar sentiment at historic lows, the dollar continues to be about as popular as a leper. In contrast, the yellow precious metal continues to be the belle of the ball. Today it closed at a new, all time high at the Comex. The December futures contract closed at $1045, decisively higher than even the intra-day high in March 2008 (when the fall of Bears Stearns lead to a panic).

Here is a short video covering the recent move and a look ahead at what’s coming up at the hard right edge of the chart (make sure to watch till the end for a bonus):

It wasn’t too difficult to anticipate a successful break above the hitherto challenging $1000 level. An analysis of the investor sentiment in gold revealed a mostly bland response to its advance this time around. Unlike previous rallies.

As well, gold’s seasonality was the wind at the back of its uptrend. However, as you’ll notice from the seasonality chart in the previous link, a pull back is to be expected for gold in October. At least, that’s what has been average historical pattern.

Checking in with the K-Ratio (the ratio of the price of gold to the Philadelphia Gold Bugs index), we see it in neutral territory:

This recent move helps to cement the long term uptrend for gold, however it isn’t smart to chase it higher. Once a decisive break through tough resistance like this is made, it is typical to see a pull back to that level again as it acts as support. With the seasonality weakness about to kick in, that’s what I’d expect to happen. So keep watching this market for a good opportunity.

Also keep in mind that there are many ways to play this. You don’t have to buy gold futures or the Gold ETF (GLD). There are many highly leveraged mining companies that provide a fantastic proxy for this precious metal. The K-ratio still has room to move higher, which means that relative to gold, gold equities are not expensive.

Finally, the bigger picture is the slow decline of the dollar. I expect a rally in the US dollar, especially as the sentiment is so extremely pessimistic. But the long term trend is clear. There are some rumblings in the background that oil producing Middle Eastern countries, along with China and Russia are working together to stop pricing crude in US dollars. As well, the Reserve Bank of Australia wins a gold star for being the first among industrialized nations to start on a tightening cycle.

Often it seems our analysis of the markets are like children looking at ants through a magnifying glass. So once in a while it is always useful to take a step back and get a long term perspective. The chart below shows the inflation adjusted Dow Jones Industrial Average since 1925.

There are a lot of lessons to glean:

• While the corrections in 1929 and 1964 were of equal magnitude, the latter took much longer to play out.
• The 1960’s top (previous resistance) acted as support and repelled prices to initiate the spring rally in March 2009.
• The Dow trades at less than twice where it closed at the 1929 top.
• After more than 40 years the Dow is only trading a trifle 30% above its 1964 peak (inflation adjusted).
• Finally, the Dow managed to rise 31% since the spring rally in March 2009 - that is amazingly a pinch more than the gain from the top in the 1960’s.
• The Dow has traded in a very wide and rising trading range - so if you are really really pessimistic, you could say we are headed to 4000 (eventually)

Source: Chart of the Day

To get a full picture, compare this to the (very long term) inflation adjusted chart of the S&P 500 index.

This video features Elliott Wave International Senior Currency Analyst, Jim Martens, using Elliott wave analysis to forecast the U.S. dollar’s near-term moves.

Now through May 20, you can access all of Elliott Wave International’s intraday and end-of-day Forex forecasts completely free. Access EWI’s FreeWeek.

About the Publisher, Elliott Wave International Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world’s largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private investors around the world.

To contrast the video’s short term view, the chart below shows a very long term view of the US Dollar Index. The green/red line is the US Dollar support line going back to the early 1990’s. When this important level broke, I suggested that we could see it play out as a bear trap, similar to what we saw in 1992.

The remarkable thing about this bear market has been the rally in the US dollar, taking the index back above its long term support level. At least for now, it does looks like the important break of 80 was a bear trap (although somewhat of a big one).

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