Every day the most common question I get asked on our radio show or by email is about gold. Should I buy? Sell? Physical versus ETF? How much? You get the idea. So, obviously the recent correction in the price of gold has suddenly awakened the slumbering giants of gold ownership that something just might be going on.
On August 14 in our weekly missive we wrote in regards to the question of whether it was time to buy gold as it spiked towards $1800. We stated at that time:
"In a one word answer:
'Are you kidding me – Gold has never been this overbought before. If you ever wanted to be the poster child of buying at the top – this is it.'
Okay, not really a one word answer but here is my point. Gold is currently in what is known as a 'Parabolic Spike'. These do not end well typically as it represents a 'panic' buying spree.
Therefore, if you currently OWN gold I would recommend beginning to take some profits in it.
Could gold go higher from here? Absolutely, but that is not the point of investing. The risk of owning gold now FAR exceeds the potential for further reward.
If you don't own gold, this is the worst potential time to begin trying to get into it. It will lead to losses.
There are four identifiable levels of retracement to begin acquiring gold in the current environment and they are ranked from the least attractive to the most attractive.
1) Trend Line Support – this level has been the normal level of retracement during this bull market advance. Current level - $1600.
2) Support 1 – is the top of the previous consolidation pattern which now provides support – that level is $1550.
3) Support 2 – is the top of a consolidation phase in late 2010 which now provides support – that level is $1425.
4) Support 3 – is the bottom of that same consolidation pattern in late 2010 which provides the most support in this current trend. A pullback to $1300 would be a great entry point.
Patience is required in investing and chasing over hyped, highly volatile, and extremely overbought assets will lead to only one conclusion which was best summed up by Mr. T in 'Rocky' when he said: 'My prediction ... is Pain!'"
Of course, back in August these were just estimations. While the recent correction to the trend line support occurred at a much faster pace than predicted - the decline to the trend line and the subsequent bounce played out as expected.
However, the sharp drop to the first level of support and the break of the long term trend line now has people's attention. Back in August our predictions of a decline were widely dismissed, scoffed and guffawed. Now that the predictions have come to pass those same individuals that disregarded the warnings are now beginning to ask if "now is the time to sell?"
While the predictability of human behavior is always far more certain than the market itself; the resolutions of parabolic spikes are likewise fairly predictable ... they end painfully.
While the most recent sharp decline has gotten the shiny metal oversold on a short term basis, and does set investors up for a bounce, it is most probably just that, a bounce that should be sold into.
While we are secular bulls for commodities that does NOT mean that you cannot experience sharp declines in commodities along the way. The problem for most investors is that while they have the best of "intentions" of holding a position long term - the reality is far different when a sharp drop in price sends them fleeing for the exits.
We have witnessed this very similar action not so long ago. The last time that we witnessed the culmination of an outsized price spike in gold was in 2007-2008. The conclusion of that spike was similarly painful with sharp drawdowns in price, reflexive bounces and further drawdowns until the bottom was finally reached. Then, just as we see today, the same people that were buying gold into the spike became net panic sellers on the resolution.
The attendant chart shows the history between the price of gold and the percentage deviation from the 13 week moving average on a monthly basis. The majority of the time when gold negatively deviates from the monthly price by 2.5% it has generally been a good buying opportunity. However, in recent years, as individuals have piled into gold, that volatility has become much greater and negative drawdowns of 6% or greater have become more common.
How far could the current price decline be? If we go back and look at the monthly price chart on gold in early 2008 as the peak was achieved the decline to the bottom was roughly 30%. That decline also coincided with the recession which chased money out of all assets as the financial crisis set in. Today, a similar 30% decline would take the price of gold all the way back to - wait for it - the beginning of 2011. In other words, while a 30% correction would be extremely painful for individuals who bought into the price spike - the reality is that a corresponding price correction during the next recession in 2012 would only take away the gains for 2011. This hardly seems cause for alarm or claims that the secular "bull" market in gold has come to its inevitable conclusion.
Don't get me wrong - the bull market in gold WILL eventually end and the price WILL collapse back to extremely low levels. Just as it did post the inflationary period of the late 70's. However, that event is likely several years away and we will need to see a much strong economic environment for that to begin to occur.
Here is our take on gold in the coming months.
- We have entered an intermediate term correction in gold that will most likely last 3-6 more months
- Any short term rallies to the longer term uptrend should be sold into for now. Take profits, limit losses and raise cash.
- If Europe fails to resolve itself and a financial crisis emerges gold prices will initially drop rapidly as risk assets are unwound indiscriminately.
- Any further decline in the euro which forces funds into the U.S. dollar will likewise keep a lid on gold prices.
The resolution of the parabolic spike in gold prices simply takes time to resolve. While that resolution can be painful to emotional investors - the long term outlook for gold has not changed. There has been no real resolution to the global economic weakness or problems that currently engulf the globe despite mainstream media chants that the economy has turned the corner. We strongly suggest raising cash on any near term rallies and look for the resolution of the current correction to provide an excellent long term entry into gold.
Disclosure: I am long GLD.