'Black Box' Pricing Of Gold Vs. 'Death Of Gold' Notion

Includes: GLD, IAU
by: John Wilson

Gold price as a "black box" system

When we think of a "black box" we imagine something that is closed with its inner workings unknown and inaccessible. The definition from Wikipedia is: "... a device, system or object which can be viewed solely in terms of its input, output and transfer characteristics without any knowledge of its internal workings..."

Input would be analogous to the factors that influence the price of gold.

My thesis is that the factors that influence the price of gold are so numerous and some are unknown or unmeasurable, that it is impossible to conduct a meaningful fundamental or economic analysis of the price of gold. It would be like taking two dozen random prescription drugs (and maybe a swine flu shot) and trying to predict the reaction to the combinations.

Why bring this up now? Anyone who is reading an article about gold should know that after peaking at $1,920.30 (Spot gold) and $1895 London September 5 & 6, 2011, gold has been in a downtrend for 19 months until now (March 2013). Its most recent low was on March 6, 2013 at 1574 (London). With the 19 month decline in the price of gold, this has led once again to declarations of the "Death of Gold" or $1200 gold or even $800 gold.

Regardless of whatever price gold has dropped to, the same mantra is heard over and over "Gold is going lower." The rationale is sometimes nothing more than, "if it drops below $1550, then it will go to 1400. It won't hold there and then it will have to go to $1200," and so on. Or "Goldman Sachs is predicting $1200 for gold" -- therefore it must be so (they only have your best interests in mind, don't they?).

So yes, I am responding to proclamations of the demise and death of gold. To be fair if gold was going above $2000 right now and there were calls for it to inevitably go to $5000, this same criticism would apply to calls based upon fundamental analysis for $5000 gold, (although this may not ultimately be out of the question.)

There are two basic ways in financial markets to attempt to put a price on an asset: (a) Fundamental or economic analysis, and various forms of (b) Technical analysis. Those who would attempt to fix the price of gold (the $1200 call) using the first method - fundamental, would attempt to evaluate and analyze all the factors that influence the price of gold. First of all they would have to KNOW what all the factors are. Then they would have to know how WEIGH them as to materiality. Then they would have to have all current statistics for the factors.

Then there are other factors which cannot be analyzed: In the classic book Technical Analysis of Stock Trends, by Edwards and Magee the authors comment that there are:

...factors that defy analysis and for which no statistics are obtainable... the hopes and fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, as well as their needs and resources...

The statement that "The price of gold should be $1200" cannot be made from an exhaustive analysis of all the factors that influence the price of gold because some of the most important factors cannot be known or measured. There are easily dozens of factors which would have to be know and analyzed. Here are some of them; you may be able to think of others:

Production vs consumption: demand for jewelry demand for coinage, demand for bullion

Future supply

Future demand

Investment demand (world, not just U.S.)

Vaulted gold stocks (quantities are estimated or unknown)

Currency (existing paper) that may require gold backing

Deficit spending of expansive governments

Central Bank printing and currency expansion, in US, and any nation that has a CB that may print.

Government(s) sovereign debt default - a real possibility.

Credit Inflation of currency (easy lending)

Credit deflation of currency (tightening).

Price inflation of materials and goods and oil

price deflation of the same

Economic Ratios: Gold to Oil, Gold to stock market, Gold to Silver

Unknown Factors - there is a glaring lack of transparency. Actually the CBs are secretive.

  • Central bank holdings (a mystery)

  • Central bank sales (unreported) to suppress gold (as it is an indicator of currency inflation)

  • Asian, Russian and other Central bank purchases to build gold reserves to back their currency

  • Psychological and Sentiment factors: not just in the US but all markets worldwide.

  • Fear of currency devaluation due to fiscal stimulus or debt monetization schemes (multiply by number of nations with large sovereign debts), this is unmeasurable

  • Unknown unknowns - we don't know what they are. (Donald Rumsfeld)

Anyone who has comprehensive knowledge of all of the above factors and is able to weigh them and thereby accurately predict the price of gold is omniscient. Get in touch with me and I will subscribe to your investment newsletter.

The statements that "Gold is dead" or "Gold is going to $1200" are nothing more than opinions or in some cases, rantings.

How then can the price of gold be known? It can't be nailed down (for very long); it is always changing because of the behavior of governments and central banks and the above factors that are always varying -BUT from any current market price you can have your own opinion/beliefs and sentiment based on what you know (your personal "FA"), but don't act on it yet. This is where Technical Analysis "TA" comes in.

One of my favorite quotes regarding trading is a saying of Harry Browne: "Fundamental analysis tells you what to do; Technical analysis tells you when to do it."

Quoting again from Edwards and Magee, a short definition of technical analysis is given:

It refers to the study of the action of the market itself as opposed to the study of the goods [stocks and assets] in which he market deals... the science of recording [charting] usually in graphic form... actual price and volume of a certain stock...

Starting from the current market price, TA will tell you what gold is (and has) been doing and will help reveal the trend.; TA will help you discern the support and resistance levels that are in play and the trend. This means identifying:

  • Support and Resistance levels

  • Possible price reversals at support levels, Possible reversals at resistance levels

  • Trading Volume that may indicate accumulation at support levels (what would the opposite be?)

  • Trend Lines that are in play

The market action will very soon reveal if "Gold is going to $1200" and if GLD is going to break below 150. The above indicators would suggest as per (NYSEARCA:GLD) that gold may have bottomed Feb 20 at 150.84, and held at support, double bottoming on March 8 at 151.40 although a "breakout" has not occurred. Two stocks that I own and watch, Goldcorp (NYSE:GG) and Hecla (NYSE:HL) have shown signs or bottoming, but more than that, show signs of accumulation - an increase in volume observed with a lifting or increasing in price.

For an investor new to technical analysis, here is a quick "working man's" do-it-yourself exercise: Using an "Interactive chart" on Yahoo Finance, pull up a (GG) 3 month bar chart with volume. Observe price basing at $32 and beginning on March 6, to lift with volume swelling. Do the same for (HL). You can look at (GLD) too and it will show positive price action, although the volume is not confirming that yet.

The mining stocks are still far below their significant moving averages, (50, 100, &200), even so much that they have been considered oversold, but the overhead MA s do represent overhead resistance.


Those who make proclamations based on their fundamental analysis that gold is dead, doomed and declining to $1200 or $1000 are most likely analyzing only a fraction of the factors that determine the price of gold; their predictions are nothing more than opinions. They cannot see all of the inputs that result in the price of gold. These factors are many and complex and always changing. They cannot see inside the "black box." Only the market can synthesize all of these factors to produce a price - a temporary price.

There is the risk of not having a position when the market in gold moves because one was scared off by fear mongering and rantings which are based on opinions or feelings of gold detractors.

Observation of Fundamental factors can help determine your opinion and sentiment and the direction (philosophy) of your trading, but technical analysis will verify if your direction is correct when it coincides with the trend. Go with the trend.

Disclosure: I am long GLD, GG, HL, SIL. 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.