The last days have been testing for gold investors to say the least. Few gold holders can, most likely, honestly say that they're unaffected by the recent price action for gold. If you aren't in panic mode, then you're still probably thinking about what's going on. Let's try to get some perspective on what has transpired and what we can expect going forward.
After slowly drifting downwards from the close above $1900 back in September 2011, gold has unsuccessfully tested the $1800 threshold three times.
Then suddenly on Friday last week, gold fell by as much as $84 to close at $1477. On Monday the sell off was even more aggressive, taking gold down below $1400 for the first time in over 2 years.
So what has happened? We all know that the key drivers for gold such as negative real interest rates, heavy central bank stimulus, increasing central bank reserves etc. still apply today - just like it did a few years back.
Are the reasons behind the fall that Cyprus is selling their reserves, and that there is a risk of some of the PIGS countries doing the same? Or is the demand waning in countries like China and India? There are so many reasons floating around the major news channels - everyone and their mother having an explanation for why the gold bull market is over. Much of it is nonsense, and not something you should base investment decisions on. Ask a reporter, broker or news anchor for an opinion and they will give you one.
In reality, what has happened is that the price action of gold has been problematic, partly due to the difficulties in breaking through $1800, but also because it very recently hasn't responded the way you would have assumed it to - during for example the crisis in Cyprus.
One of the most important recent events was gold breaking through its key support area of around $1550. Every time we've reached that area in the past there has been buying. On Friday there were no buyers in sight. This means that gold has fallen by over 20% since its 2011 top, which puts it in official bear market territory.
A secular bull or bear market always has cyclical periods of price increases and price drops. So, just because we've seen a 20% correction doesn't necessarily mean that the secular bull market is over. It does require us to think about the situation though.
So what can we expect going forward? After falling hard like it has over the last couple of days gold will most likely consolidate and then either move up or down. But let's be realistic here. There is an overhanging risk that gold could go lower given the recent price action. Just because we've seen heavy selling doesn't mean that gold will go back up and test $1800 again.
The market is high on stimulus and money is flowing straight into speculative assets such as stocks. That's why we are continuing to see new record highs on the major exchanges, and probably also will see strong performance for more risky assets such as emerging markets going forward.
So is it time to throw in the towel? I don't think so. Here's why.
Yes, we may see gold drift even lower. Key support for gold is currently at $1315. If that level is broken gold will go down even further. Perhaps as low as $1000, which is where gold was during the financial crisis…after which it made a push of close to a 100%.
Have drops of over 20% happened before? Sure it has. In the current secular bull market we saw declines of this magnitude both in 2006 and in 2008.
In the secular bull market of the 1970's, gold climbed to $185 on Feb 24, 1975 and 18 months later on August 25, 1976, it had fallen 43% to $105. After that it made a new high in 5 years of $850.
Until we see a definite shift in policy from the central banks and the Fed the drivers for gold still are valid. The Bank of Japan is increasing the money supply explosively to break the cycle of deflation. The ECB is continuing with their stimulus. Other countries are follow suit. Just the other day South Korea launched a $17.2 billion fiscal stimulus plan.
For the Fed specifically, we need to watch out for either an inflation rate above 2.5% or more than 6.5% unemployment. That will signal a potential shift in policy which will have an impact on precious metals prices.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.