Gold Has More Room to Fall

Includes: GLD, IAU
by: Sean Hannon

Investor psychology is fascinating. Studies have shown that when faced with an impersonal decision such as picking investment A or investment B, people usually act in a rational manner. However, when an emotional attachment is involved, we are much more vested. Whether it be a person unwilling to sell a stock inherited from grandparents, or someone who tends to view a stock through a certain prism because he loves the product (examples include companies like (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) whose users are extremely loyal), set beliefs are difficult to overcome.

Attachment to ideas is prevalent across all investments, but no more so than when it comes to gold. Just mention the yellow metal and the opinions begin flying. Believers, most commonly referred to as “gold bugs”, stress that over the centuries gold has served as a store of wealth, is “true” money, and that over time the experiment in manipulated fiat money will eventually collapse, as history has shown it always to do, and the holders of gold will be the last men standing. Those who look down upon gold seize upon John Maynard Keynes’s view that the metal is a “barbaric relic” that yields nothing, has little industrial use, and is worth only what people will pay for it. With such staunch views on each side, it is not surprising that debating the merits of investing in gold triggers constant bickering.

As neither a gold bug nor a gold-hater, I reside somewhere in the middle. The arguments of both sides hold merit so my perspective about gold is a blend of both points of view. I am uncomfortable that holding gold produces no income and thus makes it impossible to discount cash flows in order to determine a fair value. Also, the metal has little use other than as a store in value and is therefore subject to wide price swings based upon investor emotion.

In spite of these negative factors, gold has positive attributes as well. Since bottoming in 2000, gold has finished higher ten consecutive years. Such bullishness has been largely ignored as each rally is met with mounting skepticism.

Seeing little need to delve into a nuanced debate, I channel Jesse Livermore. As told in Reminiscence of a Stock Operator, “there is only side to the market; and it is not the bull side or the bear side, but the right side.”

For over a year, EPIC Insights has owned gold via the SPDR Gold Trust (NYSEARCA:GLD). From the October 2008 low near $700, a dependable uptrend has guided prices higher. With each decline reversing at this barrier, patient investors have been rewarded.

However, nothing lasts forever. During a chaotic opening week which saw gold decline over $50, the longstanding uptrend was violated. In doing so, further bearish pressure occurred when both the 10- and 50-day moving averages (MA) were violated.

For those hoping this quick decline will offer a similarly dramatic reversal, good luck. A monthly chart shows gold is still overbought. Trading well above monthly trend lines, further downside is needed to reverse sentiment and return to a balanced market.

Studying both the daily and weekly charts, a decline toward the 200-day MA ($1,275) is likely. This move would eliminate overbought sentiment and balance the expected return and potential risks. For those owning the commodity, it also means steep losses. Having harnessed the bullish trend to large gains, I see no need to passively accept losses. Owing gold has worked in the past and will again in the future. Until that time, we shall head to the sidelines and await new opportunities.