Friday was a nerve-wracking day in the gold market, with the spot price plummeting 5% in a single day. History suggests that the recent sell-off in gold is soon to dramatically reverse and that a new all-time high can be expected over the next 12-months.
It's incredible how fickle the market is. Especially at major turning points, the investors have a tendency to behave more on emotion than logic. Investors and financial experts alike seem unable to focus on anything other than the previous few weeks of market activity and tend to believe the short-term trend will continue indefinitely.
Last week, the stock market reached a new all-time high. The stock market last peaked in October 2007 at a new all-time high. October 2007 is the same month this YouTube video was released, warning people of the coming stock market crash and the next Great Depression. Over the ensuing 17 months, the stock market shed 57% of its value and the word "Depression," which was previously unused in the mainstream media, had become a household word. Below is a chart of the S&P 500 index for this period. The red line is the 200-day moving average price.
What is very important to recall about 2007-2008 is that commodities of most varieties set their own all-time highs several months after the general stock market itself. For instance, it wasn't until July of 2008 that crude oil set its bubble peak of $147/barrel. The first half of 2008 was also when the price of rice and wheat had climbed so high that the public was convinced we had worldwide scarcities of these staples. What had happened in reality was that market speculation had driven the prices so high that people were less able to afford these food products, which ended up rotting in warehouses.
Specifically, relating to gold, by March 2008, the U.S. dollar was hated and gold was absolutely loved. And why wouldn't people have loved gold at the time, it had just gained 51% over the previous seven months and achieved a new all-time high closing price of $1011.25/oz. Below is a chart of the largest gold bullion fund (GLD) for this time period. Again, the red line is the 200-day moving average price.
Then the market flip-flopped 180 degrees over the following half-year as gold lost 30% of its value and the dollar rose sharply. Soon investors loved the dollar they had hated just months earlier and were questioning the merits of gold. However, by February of 2009, gold had regained almost all of its lost ground, increasing 40% to $989. This whole cycle of top to bottom and back to the top happened in a period of less than a year! Shown below again is the gold fund, GLD for this period.
By mid-2011, gold was even more loved after increasing 45% over just seven months, reaching another new all-time high at $1,913.50/oz. In fact, gold was so popular that the gold fund briefly became the largest exchange traded fund in the world by market capitalization. Needless to say, the U.S. dollar was getting no respect at that time. The chart below shows GLD for this period.
The past year-and-a-half, gold has definitely been a bumpy ride as you'll see below. However, even during this downtrend, gold has staged three rallies of 11%, 15% and 16%. Considering how extremely oversold gold is at the moment, to not get a rebound of 15% would be truly shocking. A 15% rise from Friday's close is $1,704.
And let's not lose sight of the long-term trend in gold. On July 20th 1999, gold closed at a low of $252.80. Since then, it's been in a staggering bull market for over 13 years. Today, even after the recent price collapse, gold is still almost six times higher. The chart below shows the gold bullion fund, GLD since it was introduced in 2004.
Has the long-term trend in gold changed? Perhaps, but that seems highly unlikely in today's environment of massive government inflationary efforts. No longer is the U.S. the only country playing the Quantitative Easy game either, with Japan recently jumping in and playing for blood. All countries will be forced to devalue their currencies to remain competitive with their exports.
The market is currently in full-blown fear mode when it comes to gold. There's blood in the streets in the gold mining sector as the fund of gold mining companies (GDX), has dropped 52% from its 2011 highs and the fund of junior mining companies (GDXJ), has plummeted a jaw-dropping 68% from its all-time high.
As per usual, I believe the market is reacting irrationally right now. The risk of loss for the S&P 500 is somewhere in the neighborhood of 60% as it's perched again at all-time highs whereas the gold market has nowhere to go but up over the next few months.
In February, it was reported that investment mogul George Soros cut his holding in GLD in half in the fourth quarter of 2012. That is then; this is now. Gold has already dropped 15% since its fourth quarter peak. Why did he only sell half and not all of it? Is Soros buying it now? These are the relevant questions, not what he did as long ago as October.
The final straw was Goldman Sachs recommending on Wednesday that their clients sell gold short. If you read the article though, you'll see that the price they are targeting is $1450, which is only about 2% below where gold closed on Friday. Important detail, don't you think?
It's also important to remember that Goldman was caught up in the crude oil bubble of 2008, suggesting that oil could hit $200 per barrel. If you check out the actual article, you'll see that they qualified their prediction, saying many other things. However, the public at the time heard $200 per barrel and began expecting $200 per barrel oil. Of course, just a few months later, oil dropped well below $40 per barrel.
The markets have a tendency to behave like a pendulum in that the further an asset departs from its 200-day moving average, the more dramatically it moves in the opposite direction when the trend changes. Another way to look at it is like an elastic band, where the further it is stretched, the faster and harder it snaps back.
At this point, it appears that the gold market is giving the emotional public a final head fake before heading in the opposite direction. And it's not going to be a little move higher, but a rapid, sharp rise similar to the past two times gold set its all-time highs.
In 2008, gold rallied 51% in seven months to set a new all-time high. In 2011, gold rallied 45% to an even higher all-time high. This time around, gold would only need to increase 30% to set a new all-time high. To break through the noteworthy $2,000 level, gold need only rise 36% from its recent bottom.
I expect gold will top out near $2,100 within the next 12 months. With gold increasing 42%, one can only speculate how high gold mining funds will rise. The minimum targets appear to be their highs from September, which would be 70% for GDX, 85% for GDXJ and 115% for GLDX.
Has the 13-year bull market in gold ended? I wouldn't bet on it and I'm certainly not.