The Gold Bull; time for a breather or?

Everyone is now turning bullish on this yellow metal.

Sales of Gold coins in the U.S are up over 70% and rising

Chinese demand increased 12% in the 3rd quarter setting a new record.

The Royal Mint (UK) stated that demand soared almost 400% in the 3rd quarter in comparison to the same period last year.

Central bankers have also joined the game; they have suddenly decided that is time to buy Gold after dumping tons of it at significantly lower prices.  Mining companies like ABX have also finally decided that its time to close their hedge books now when Gold is trading in record high territory. When Gold was trading in the $300-$500 ranges, they did not think it was a wise move.  As market timers both entities are at best terrible and so caution is warranted now that they have both suddenly turned bullish.

The World Gold council states that demand for Physical Gold dropped last quarter. Could it be that speculators and late comers are pushing this market higher in their quest to get in on the action?

LONDON (Reuters) – Gold demand fell 34 percent in the third quarter as high prices weighed on investment flows and led to a slump in jewelry buying in key markets like India and the Middle East, a World Gold Council report showed on Thursday. But speculation in gold futures and expectations for more official sector bullion buying are keeping prices elevated despite a dearth of physical demand, according to the WGC’s investment research manager Rozanna Wozniak.

“For most of last year, the buying was very physical,” said Wozniak. “(Now), it seems to be more financial market-driven, by some of those other less visible instruments — derivatives, futures, over-the-counter transactions.” “In terms of why it is happening, we have had some good news coming out from the central bank sector, as well as the fall in the U.S. dollar,” she said. “That says something about potential future demand.”

A 200-tonne gold purchase by India’s central bank pushed gold prices sharply higher in early November. Prices hit a record above $1,150 an ounce on Wednesday as momentum buying pushed prices through key technical resistance levels. But high prices have pressured physical offtake this year as consumers shied away from the metal, even as large investors and central banks bought gold as a portfolio diversifier. Full Story

The Gold story is in some aspects eerily similar to the Oil story of 2008.  From Jan 07 to June 2008, oil moved from low of $50 to a high of roughly $145 dollars, a stunning gain of almost 190%. When it traded past 120 it was already overbought, but yet all the experts predicted that oil could not drop as production was falling and demand was increasing.  They predicted oil would be hitting the $200 mark in the near future.  Oil did trade higher; it traded as high as $145 before cracking wide open. The fall was stunning; oil traded as low as 30 before a bottom was in place. While Oil is trading significantly higher it has a long way to go before it surpasses its 2008 highs.

Gold has had a very strong run in the last 13 months; from low to high Gold is up over 71%.   From its 2001 lows, to its current high, Gold is up roughly 388%. Speculators are entering this market in droves and speculators by nature are not long term investors.   The pattern once again is very similar to the one oil put in 2008 before correcting.  Speculators, especially momentum traders can open up short positions just as fast as they can open up long positions. They have no quibbles about trading in either direction; they are only there to make money.

The chart below clearly indicates how strongly Gold has rallied over the past several years. If one examines any major bull market, one will always find that it experienced at least one very severe correction and many strong corrections in between setting new highs.

Everywhere you look you find a bullish case being made for Gold; from central bankers to the little guy on the street everyone thinks Gold is the way to go.    Has history not shown us so many times that when everyone thinks something is a good play it’s usually a time to be cautious? Examples of this are the Dot.com bust, housing bust, the sudden drop in bond prices this year after everyone thought that bonds were the place to be in, the collapse in the price of oil in 2008, etc.    One must be especially careful and vigilant when a contrarian investment s suddenly starts to become a main stream concept.

Conclusion

Gold still has a long way to go before it puts in a final top.  We would not be surprised to see  Gold  trading north of $3,000 at some point in the future.   Like all markets it will go through corrective phases. Some of these corrections will be mild, some strong and some severe. The higher Gold trades the stronger in nature these corrections will be.  We are pretty sure that Gold bugs were not busy opening up new positions in the $900 and $1000 ranges. Gold bugs loaded up in the $300-$500 ranges and used all strong pull backs  after that to add to their positions. Thus the majority of the players jumping in at these lofty prices are either newcomers and or speculators/momentum traders.  These chaps always come to the party late. Our view is simply that Gold is now trading in the  extremely overbought ranges and from a risk to reward ratio one would be better of waiting for a pullback before deploying new money.

Other factors to consider

The Dollar has not traded below its April 2008 lows.  Considering that Gold has put in a series of new all time highs in the past few months, the dollar should have put in series of new all time lows. This has not occurred and so we have a very large negative divergence here.

According to the World Gold Council demand has dropped 34% in the last quarter.  If physical demand is down, then it indicates that most of the new positions are being opened via the futures market, an area that is home to speculators.

From a mass psychology perspective, one must pay close attention  when those that were busy making fun of an investment, change sides and jump into it, for  a critical point has been reached.  Central bankers purchasing Gold now that is something to sit back and seriously reflect on; were they not happily giving  Gold away for next to nothing a few years ago as they viewed it as a worthless investment? Why have they suddenly become Gold bugs, especially when Gold has been setting one high after another for the past few months?  Should we be viewing this from a contrarain angle?  When they were selling buying was the right thing to do. Now that they are buying perhaps its time to take some money of the table or at the very least wait for better prices before committing new funds. We should also remember that no market no matter how strong it is can rally upwards indefinitely without letting out some steam.

The Gold bull is far from over, but given that it is now extremely overbought, a pullback in the markets should not come as a surprise.  If the pull back turns out to be a strong one, it should be viewed as a buying opportunity.

Why are there so many people who never miss an opportunity to miss an opportunity?

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