Since the Fed announcement not to reinitiate quantitative easing on Tuesday, markets have sold off unanimously as investors flee for safer shores. Those safer shores, it seems, do not include gold, which plunged 4.6% in Wednesday's trade as the entire commodity complex sold off violently. Gold's major sell-off, some 9% in two days, means that the metal is entering technically oversold category by most standard analysis, but that technically bullish indicator must be viewed in the context of a larger, more significant technical breakdown: a close below the 200-day moving average.
In the context of recent trade, that puts gold in uncharted waters--it has not closed below its 200-day moving average since January '09. And while it has generally paid to buy gold in an oversold condition over the past two years, a violation of the 200-day moving average hints that the larger trend in gold might be at a turning point. After one of the most remarkably consistent bull runs for any asset in recent memory, gold is potentially at a turning point. And at key turning points, markets can stretch the extremes of bollinger bands and stochastic oscillators, turning what would normally be strong buy signals into regrettable entry points for investors using these indicators without regard to the context of the trade.
In many ways, the current gold trade feels a lot like 2008, when gold surged above $1000 in March, pulled back some 15%, and then rose back to just below the $1000 mark in July before buckling a month prior to Lehman's collapse. When all was said and done back in 2008, gold bottomed out 30% below its March highs. The good news for gold investors: that bottom came on November 13th, while most other markets were mired in turmoil due to the Lehman bankruptcy.
To extrapolate that to today, gold currently stands 17% off its August high. Moreover, while the markets continue to deteriorate and liquidation has been the order the of the day for nearly 4 months, the fundamental picture remains quite similar to where we stood at the start of 2008. The cast of characters has shifted from the US to Europe, but otherwise, the story remains the same. Markets are still saturated with large amounts of paper from insolvent issuers, and banks have nowhere to unload this paper. While the Fed and the ECB have so far resisted the idea of further quantitative easing to help the banks unload their bad debts, one has to wonder if they will hold that line in the instance that a major bank failure is imminent. My guess is that both the Fed and the ECB are trying to walk a tightrope, balancing the need for QE with the fact that it will provoke more outrage and scrutiny from the populace. But I doubt that they have had some philosophical conversion to the principles of sound money, and so I would presume that the printing presses would be manned in the event of an emergency. Judging by the deterioration of European debt markets, that emergency might be closer than the Fed or the ECB is willing to admit.
If we are really replaying 2008 in the sovereign realm, then it would seem that while gold could go lower, it should begin to base in the $1350 to $1450 range. And if the last two years are any guide, gold could end up rising to $2500 or perhaps higher over the next 3-5 years. If Europe collapses, the whole world will be printing this time around. That might be the trigger for gold to form the final, topping phase of its decade-long bull market.
But for now, all that is speculation based on the future course of events. What we know is that gold has broken down technically, and that means that over the near term the path of least resistance is down. While gold may rebound in the coming months, the safest way to play is to cut position sizes or sell out until the market corrects further and shows signs of beginning a new uptrend. While there are plenty of reasons to remain bullish on gold in the long term, the near-term road promises to be bumpy.