A Bear Threshold From A Gold Bull

Over at Seeking Alpha, contributor "Gold Price Today" points out that gold held up fairly well as compared with the stock market last Friday. Instead of going into a tumble 'til the end of trading, gold bottomed in the morning and held its support level of $1,090. He (or she) hints that the buy end of the greenback carry trade is mainly higher-yielding risk assets, not gold.

The money quote's near the end of the piece:

The price would have to drop below $1000 and stay there for the long term picture to turn bearish. In this case we’d look to see if India, China and other central banks would look to add to their reserves.

Therein is an important point. I know next to nothing about how PRC monetary officials tick, but I wouldn't be surprised if there's been a private goal set to buy reserve gold at a beat-India price. For the record, the central bank of India bought the 200 tons of IMF gold at about $1,050.

Home Sales Data Hit The Market

The release of the December home-sales data revealed that sales dropped more than expected - a whopping 16.7 percent. The gold market, after gold descended to $1,092 in a two-steps-down-one-step up pattern, rose on the news.

Interestingly - but only in the very short term - gold and the U.S. dollar moved in tandem. At about the time gold slumped to $1,092, the U.S. Dollar Index bottomed at 78.183. The announcement pushed the greenback up to about 78.3. Since then, the Index has sunk back to the 78.2 level.


This tandency, I should say, is only presented as a curiosity. It's the gold-market equivalent of a man-bites-dog event, if not a silly-season story. At any rate, the fluctuations in both today have been and the usual inverse correlation has reasserted itself.

A Contrary Opinion On The Gold/Interest Rate Relationship

It's from Seeking Alpha contributor Bruce Pile. Given the obvious inverse relationship between the U.S. dollar and the gold price, and given that currencies tend to be strengthened by rate hikes, it's no wonder why an impending Fed rate hike has gotten gold investors spooked.

However, that's only one of two possible reactions:

"Oh my, they're going to defend the dollar, I'd better sell my gold" or "Oh my, there's an inflation threat, I'd better buy some gold". Most of the commentary I've been seeing tends to be of the first type - if they start to defend the dollar, gold will go down.

In the 1970s, as Pile points out, investors acted in accordance with option #2. The overhanging question is, will they go for door #2 this time 'round?


Not mentioned is a real game-changer, one that would signal the arrival of an all-out bubble climax in gold. In 1979, gold shot up while the U.S. dollar was rising too. Since the inverse relationship between the greenback and gold is so intuitively obvious, this decoupling made for a real Bullish Derangement Syndrome until the gold bubble popped in early 1980.

Right now, no one's even suggesting it as a possibility.

John Tamny Suggests Gold As Proxy For Inflation

John Tamny, the editor of RealClearMarkets.com, has suggested using gold as a proxy for inflation after debunking two conventional definitions of the phenomenon. Both monetarist measures and the overheating hypothesis have been found wanting, and both are easy to discredit nowadays. On the other hand, gold - because of its apparent uselessness - makes for a good proxy of inflation. Rather than use a metrical definition, Tamny describes inflation as a period when capital moves into hard assets and out of business uses.

[R]ather than a measure of prices that change for various reasons that have nothing to do with currency policy, inflation is at its core the painful process by which capital flows to the hard assets of the earth and away from innovative, wage-creating industries. As individuals we don't so much hate inflation for the rising prices as much as we balk at it because our chances to capture good jobs and good wages are compromised for capital essentially hiding.

As the rising price of gold has revealed throughout the decade we've been inflating, no matter what the more quiescent government measures of consumer prices have been telling us. A weak dollar explains our economic unhappiness because a weak dollar is what has made capital disappear....

In short, inflation is about capital going on strike...

His definition won't please monetary economists, but he does have a point because money is fungible. There's no iron law saying that an increase in the money supply must push up consumer goods exclusively; other goods can be pushed up too.

A sharp economist will note that he leaves out a particularly insidious kind of inflation, one that's quite evident in the PRC right now. Jacking up the money supply, under certain economic conditions, induces a bubble in the capital-goods arena. As a result, too much capital is diverted into "innovative, wage-creating industries." This kind of bubble is the most insidious because it appears the most sustainable and benign. Who doesn't like growth?

In reality, it's the closest bubble to the mythical one-hoss shay...and the one most likely to induce depression when it finally pops. We've seen what happened to the U.S. housing market after the residential real estate bubble came and went. Imagine that same fate exerting its grip on the producers' end of things.

Gold Skeptic Returns, With Same Message

After receiving some voluble - and, using his own word, "cogent" - criticism for his earlier thumbs-down on gold, the Toronto Star's David Olive has returned to the same theme. This time, he points to other commodities that have rose at a greater rate than gold has in 2009. Not mentioned is the fact that those commodities (unlike gold) were down hugely in 2008.

He's softened his tone, but the message is still the same. Of interest is his quote of Doug Kass near the end of his piece:

The gold bears seem more certain of themselves. Doug Kass, forecaster at TheStreet.com, includes among his forecasts "the price of gold topples" to $900 by the beginning of the second quarter of 2010, and "the U.S. dollar explodes higher." That latter would be bad for gold; its upward momentum has been tied to expectations of the greenback cratering.

Doug Kass is the same person who said that U.S. stocks presented "the buying opportunity of a lifetime" right at the March lows. He's a short seller by trade, and he seemingly sees a short-term shorting opportunity in gold. His bullish prognostication for the U.S. dollar, given its recent performance, is plausible.


However, confident bears and skittish bulls make for picture that's consistent with an oversold market.

Gold Turns Up After

After a Friday drop that took gold's price within speaking range of its December interday low, the price of the metal turned up. Early morning trading saw $1,100 bested; as of about 5:45 AM ET, $1,105 was almost reached. Starting just before 8 AM ET, though, gold fell below $1,100 and even below $1,095 before recovering. The Kitco Gold Index, even after the spill, credited $4.40 of the rise to predominant buying as of 8:30 AM.

The greenback hasn't moved much since the start of weekly trading, but what movement there's been has been up. As of 8:59, the U.S. Dollar Index jumped up as high as 78.338 before retracing somewhat.

As this Globe and Mail report recounts, the push-up in gold is likely due to bargain-hunting.

“[Prices] are recovering a bit,” said Eugen Weinberg, an analyst at Commerzbank. “The slump of the last week might be considered by some bargain hunters as being an excessive one.

“Some see in gold protection going forward, if the correction on equity markets continues ... but also there is some physical buying at the current levels after the strong decreases.”

Later, though, the article also says that Indian gold buying was "in limited quantities" even below $1,100.

This Bloomberg report also mentions bargain-hunting, but starts off with attributing the rise to expectations that the U.S. dollar will continue to fall. (As noted above, those expectations have been confounded for the moment.) Later in the article, it's hinted that platinum demand has cut into investment demand for gold.



The gold-at-a-discount indicator closed last Friday at 10.20, and it sunk interday to below 10.10. As this post explains, I'm now presenting it as an item of reader interest. A closer look at it shows that it has a tendency to lag when the gold market turns up. Presumably, that's because GLD buyers push the ETF up to a greater degree than gold traders push gold itself up when the metal begins rising on a sustained basis.


This daily chart of the U.S. dollar, courtesy of Stockcharts.com, doesn't given much ground for gold-bull optimism:



As can be seen, there's now a clear pattern of higher highs and higher lows - coming from a time when the U.S. dollar was in the doghouse. Granted that much of the rise since early December corrected an in-retrospect undervaluation of the greenback, and that the U.S. dollar is going to need some more favorable fundamentals before rallying further. The chart, though, shows that this is not the time to hope for a greenback bear market.

The economic data released suggests the U.S. recovery is still in slow gear. Of interest in the latests National Association for Business Economics survey is that members are reporting that credit, although still tight, is loosening. Its release had little or no effect on gold, except perhaps to arrest the decline. As of 9 AM ET, spot gold was at $1,095.80.

Gold-At-A-Discount Indicator: A Cautionary Note

I've picked through the workings of the gold-at-a-discount indicator, and have found it wanting for its original purpose. Over the last six-month timeframe, a simple and intutive accumulation plan - buying an ounce of gold at the beginning of each month - was less expensive than a plan that uses the indicator as a timing aid.

There are two graphs below these two explanatory paragraphs. First of all, a Stockcharts.com graph with a green line put on the 10 line. The first chart is the spot price of gold divided by the price of one share of GLD. When this ratio is below 10, physical gold is selling at a discount to paper gold as represented by GLD. Ten shares of GLD correspond to one ounce of gold.

Just below it is a chart of gold using the same timeframe. The vertical green and blue-green lines show the buy dates given by the gold-at-a-discount indicator. The buy dates are the day after the indicator goes below 10. That date-shift is crucial in understanding why it's not suited for its purpose:




At first blush, the indicator looks fine - if laggy in places. However, its purpose was to act as a timing aid for a buy-and-hold plan. In testing it for this purpose, I assumed two monthly accumulation plans.

Plan #1 was buying one ounce of gold on the first business day of each month, at the London PM gold fix as shown here. For North American buyers, the PM fix is the most likely price that'll be had. [It kicks in before lunch break, North American time.] I ignored transation costs because I assumed they'd be the same for both plans.

Here's the schedule for the straight monthly-accumulation plan:

Aug. 3rd: 1 ounce @ $959.75
Sep. 1st: 1 ounce @ $955.00
Oct. 1st: 1 ounce @ $1,004.75
Nov. 2nd: 1 ounce @ $1,062.00
Dec. 1st: 1 ounce @ $1,192.50
Jan. 4th: 1 ounce @ $1,121.50

Total: 6 oz for $6,295.50.

Plan #2 is a little more involved, as it uses the gold-at-a-discount indicator. If the indicator goes below 10 in a month, and it's the first time that month, then the ounce of gold is bought the next day using the same London PM gold fix.

If it goes below 10 a second time during the same month, the signal is ignored. The gold budget for the month is already blown.

If it doesn't go below 10 in a month, then no gold is bought during the month. Instead, the funds are saved for the next time. As of the next trigger day, a cumulative buy is made that brings the plan up to speed again. In the approximately six-month period, there were three duplicate signals [marked in blue-green vertical lines] and one month with no signal. Since there was none in December, two ounces are bought in January at the January price.

Here's the schedule for the indicator-assisted monthly-accumulation plan:

Aug. 3rd: 1 ounce @ $959.75
Sep. 3rd: 1 ounce @ $983.00
[Sept. 4th: second monthly signal; not acted upon.]
Oct. 7th: 1 ounce @ $1,040.25
[Oct. 30th: second monthly signal; not acted upon.]
Nov. 4th: 1 ounce @ $1,090.00
[Nov. 30th: second monthly signal; not acted upon.]
[None for December]
Jan. 5th: 2 ounces@ $1,121.50 each

Total: 6 oz for $6,319.50.

The straight monthly-accumulation plan costs $6,295.50. The indicator-aided plan costs $6,319.50. The monthly-accumulation plan is $24 cheaper.

Using the AM fix on the same days makes the indicator-aided plan fare worse. The straight-monthly costs $6,268.25. The indicator-guided plan costs $6,326.00. The straight monthly-accumlation plan is $57.75 cheaper.

Rather than drag it out by shifting the dates around on the straight accumulation plan, even though refraining from doing so makes the above analysis a comparative price history of a relatively short period, I'm going to stop here. The beginning-of-the month accumulation plan is the most plausible choice of dates, as people typically get paid at the end of the month or nearabouts. If the indicator can't beat at first blush, then there's something wrong with it.

Interpretation

The gold-at-a-discount indicator sounds, and even looks, plausible. Why, then, was it found wanting?

My initial interpretation of it, that physical gold sells at a discount relative to SPDR Gold Shares when gold's oversold, was wrong. A better interpretation is that GLD leaps up higher than gold itself when the gold train gets rolling again. This difference makes the gold-at-a-discount indicator, for the practical purpose for which it was aimed to aid, a laggard. It lags too much, relative to the next day London gold fix, to be of real help to a regular gold buyer.

Therefore, I'm going to change the disclaimer to read "This indicator is only intended for reader interest." And/or, "A quick test has shown that it does not help with gold accumulation plans."

In certain market conditions, it regularly sinks below the 10 line. This daily graph for the last 3 years shows that, in late '08 and early '09, it wasn't helpful for much:




I've put a daily graph of gold just below it, for comparative purposes. For the sake of reader interest.

And, I'll continue tinkering around with the concept from time to time.

For the sake of reader interest.