Gold: Where Are We Now?

Includes: CYB, FXA, GLD, SLV
by: Tom Luongo

It's the question on everyone's minds. Whatever your view of the markets is will most likely determine your answer to the question in the title. Those bullish on gold (NYSEARCA:GLD), like me, will say that this is a gift from the powers that be and it represents one of the best buying opportunities you will ever see. If you are bearish, it will serve for you as a corroboration of your position, even if your reasons for being bearish were all wrong (and believe me I heard nearly every gold bearish theory in the first three months of this year).

Obviously the bulls were blind-sided by this move down. I am both not surprised and shocked by this turn of events. However, I remain circumspect of any bear who thought we would see this level of rout - or the size of the orders needed to accomplish it - in so short a period of time. That kind of volume can only hit a market to move price, regardless of the reason you may ascribe for wanting the price so moved.

The price was moved and it took an effort far in excess of anything many were expecting to pull it off. If the reports out of London of potential failure of the LBMA are correct, then it is very possible that the major central banks had to choose between that and a very disorderly gold and, by extension, commodities market. I note that two days after every gold bearish statement possible could be made in the press, St. Louis Fed president Bullard makes a statement about needing even more QE because of low inflation.

It is also possible that this article by Jeffrey Snider at Alhambra Investment Services holds some other clue as to what is going on. In it, he argues that in the past few years, gold's major moves have been strongly tied to massive changes in repo collateral liquidity and that gold is sold in response to a tight market.

"While central banks and politicians have proclaimed the Great Crisis as a relic of the past, there is an element to all this "liquidity" coming from central banks that acts in a counterproductive fashion. We saw this with QE 2, and the Federal Reserve itself has studied liquidity under these large scale asset purchases (such as QE) and determined that QEs actually disrupt collateral chains. The bigger the QE, the less liquid the financial system grows because QE essentially removes usable collateral from the aggregate collateral pool.

The Bank of Japan and the Federal Reserve have been embarking upon the largest combined QE ever conceived - there has to be a drain on effective collateral liquidity at some point. We saw an atypical shortage of 10-year U.S. Treasuries for repo just last month. It is very possible, and in my opinion likely, that QE is again wreaking havoc on collateral systems across the globe. If that is the case, then the collapse in gold prices both indicates this illiquid stance and portends something worse developing down the road."

If Mr. Snider is correct, then we are both on the verge of a very serious credit event, as gold repos have pushed the price down to extreme levels and, more importantly, that when that crisis event is responded to by the central banks to alleviate it, gold will begin moving higher to match the amount of money printed and the repos unwound. In the meantime, there will be extreme levels of volatility. Now, the big question is what is driving this sudden drying up of repo collateral?

Is it the massive QE of the Fed and the Bank of Japan? Or is it the rise of the Petro-Yuan (NYSEARCA:CYB) which has risen steadily - now ¥6.178 - since the announcement of a bilateral oil deal between China and Russia was announced? Let's not forget the timing of the announcement by China and Australia to trade directly in the Yuan and the Aussie, either. I note that Australian bond yields have dropped strongly since the commodity markets began rolling over with subsequent selling of the Australian Dollar (NYSEARCA:FXA). The 7-year yields - which are a comfortable term to look at as it is not being targeted by either the Fed or the BoJ - have dropped 10.7% from since March 23rd to 3.057%. This nicely explains the lack of follow through by the Aussie through $1.06.

Note also that the Yuan, Malaysian Ringgit, Thai Baht and Singapore dollar (NYSEARCA:FXSG) are all trading lower as the ASEAN region continues to divest itself of the U.S. dollar. Thai and Malaysian debt has also been rising in price during all of this as well.

But, but back to gold.

I am not big on traditional technical indicators anymore for making trading decisions but I still believe that the 144 and 288 period exponential moving average have more significance than other more commonly used ones like the 50 and 200. See the current weekly chart of gold below. The 144 was the important breakdown level, coinciding with the strong support band near $1525. The two-day plunge took us to the extreme in price and very close to the 288 EMA.

Does this mean the selling is over? No, but in extreme - and fragile - situations like this, my experience tells me that the 288 period EMA is a support level far more reliable than looking back at a low price from 2 years ago. The amount of damage done to the structure of this market has a low probability of being unwound in a few days. Whatever caused the massive short selling to occur it is obvious now, two days later that there will not be a quick rally in response. The repeated intra-day selling near $1400 this week again tells me, that like $1620 a few weeks ago, there is an important supply level that must not be breached to keep momentum-based bulls out of the market.

Physical demand has gone ballistic- which makes sense- and the CME group raising margins after the crash on both gold and silver (NYSEARCA:SLV) means that the COMEX has moved closer again to being a cash market than it has been in years. With the amount of physical off-take happening around the world and on the COMEX, I would expect margins to continue to rise and cash settlement to take over at some point if prices remain in this range for any length of time.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own physical gold, silver and a few goats