Gold Is Getting Its Mojo Back

Sep. 7.12 | About: SPDR Gold (GLD)

In his Jackson Hole speech, Chairman Ben Bernanke, remarked that he sees little evidence of substantial structural change in recent years. His statement contends the argument that the current high unemployment rate will remain permanently elevated. By inference, he also indicated that Fed has more room to act to address the persistent unemployment problem. This means that QE3 is a strong possibility.

The speech turned out to be quite positive for reflationary trades and this was reflected in the price action of gold and US dollar. SPDR Gold Trust (NYSEARCA:GLD) attracted nearly $2 billion in fresh assets in August, more than most exchange-traded funds. With a gain of 4.6%, August turned out to be the best month for gold since January. Dollar index declined by more than 1.8% in August - its worst monthly decline of 2012.

GLD peaked at 185.85 a year ago on September 6, 2011. Since then it has been on a bumpy ride. During this bouncy journey, GLD dropped to 148.27 on December 29, 2011 - a 20% decline from the high and officially bear market territory. GLD's rough ride also coincided with a significant rally in the U.S. dollar. Usually, a rising dollar is bad for gold - at least for the gold contracts denominated in dollar.

Gold is a unique asset class as demand for it comes from four different sources. Nearly 42% of demand for gold in the second quarter of 2012 came from jewelry sector and 11% from technology sector. This demand is inversely proportional to the price of gold. If the price is low then more people will buy gold jewelry and the technology sector will use more gold in its products. If the price is too high then people will buy less gold jewelry and the technology sector will look for alternatives.

The demand from other two sectors - official and investment - is driven by different reasons. Official sector (central banks) accounted for 16% of gold demand in the second quarter. Central banks purchase for a variety of macro-economic reasons including to reduce the reliance of US dollar as a reserve asset. The remainder of gold demand (31%) came from investors, hedgers and speculators. This segment buys gold to profit from price fluctuations.

As the chart of gold confirms, the demand for the yellow metal was lower in the second quarter of 2012 - both from last quarter and second quarter of 2011. The demand was down 10% from last quarter and 7% from the second quarter of 2011. Jewelry segment was down by 15% and technology segment by 5% year-over-year, reflecting that gold prices were too high.

The investment segment demand declined by 23% from second quarter 2011. The investment demand for the first half of 2012 was 3% lower than the corresponding period in 2011. This means that investors saw less upside potential in the first half of 2012 than they saw in the first half of 2011.

On the other hand, central banks doubled their purchases of gold in the second quarter of 2012 from the same period in 2011. The purchasing was concentrated among developing nations. Some central banks increased buying to bolster their gold reserves and some bought because market conditions were good.

Considering all these reasons, it is not surprising that gold had a bumpy ride for most of the past year. However, now it seems that some of the troubles of gold are over. In his September press conference, European Central Bank President Mario Draghi announced an unlimited bond-buying program. With two major central banks heading towards quantitative easing style policy actions it is no wonder that gold bugs have something to be optimistic about. Even PIMCO's Bill Gross is leaning towards gold over bonds, mostly due to the reflationary bias of ECB's and Fed's actions.

The price action of GLD is favoring this optimism too. GLD has broken out of a descending triangle, which took a year to complete. A descending triangle is usually a bearish pattern. In this pattern the price keeps making lower high and keeps bouncing off the same level. It indicates that the bulls are weakening and that the bears are maintaining their strength. The normal resolution of this stand-off is a break below the lower limit. However, an upside breakout turns out to be quite bullish as noted by Thomas Bulkowski, the author of Encyclopedia of Chart Patterns. Bulkowski says that he has made more money trading an upside breakout of a descending triangle than an upside breakout of an ascending triangle.

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Within this larger pattern, GLD also formed a symmetrical triangle. On August 21st, GLD gapped up above the symmetrical triangle. Then after a brief consolidation, it broke above the larger descending triangle on August 31st, on the heels of Chairman Bernanke's Jackson Hole speech. GLD is trading above its 200-Day moving average for the first time since March 2012.

The next resistance level is 174, the high made on February 28, 2012. The measured move target for the symmetrical triangle is between 168.25 and 169.87.

Apart from GLD, shares of gold mining companies and gold-miner ETFs also provide exposure to gold. However, their performance is not always similar to that of gold as they are valued as companies and not as commodities.

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Market Vectors Gold Miners (NYSEARCA:GDX) is showing some signs of recovery. From October 2008 low to September 2011 high, GDX traced the uptrend in gold pretty well. During gold's 20% decline, GDX retraced more than 50% of its rally from 2008 to 2011. Since then it has made a double bottom pattern. After ECB's September 2012 press-conference, GDX broke out of this pattern. If the pattern runs its course then the measured target will be near 56.

Compared to GDX, Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) has had a steeper decline. GDXJ peaked in early April 2011 whereas GLD and GDX peaked in early September 2011. Nevertheless, junior gold-miners ETF has upside potential too. Like GDX, GDXJ is forming a double bottom formation. If this patter runs its course then the measured target will be near 26.50.

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Disclosure: I am long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.