A Case For Gold: Why Bulls Will Have Their Day

by: Han Jun Low

If you have been paying attention to the news lately, you would have noticed that gold has not done very well. In fact, gold has been 'slaughtered' (professional terminology varies depending on which financial news channel you subscribe to) and it would appear that there is no case for gold whatsoever. There is no inflation in the US economy with its low CPI, and there is apparently a recovery so gold is no longer appealing as a safe-haven commodity. These statistics may not paint the full picture appropriately, and I shall explain why I believe this is so. Further, I shall explain why manipulation has had a role in gold prices, and why this role is diminishing.

First, CPI is by no means an impartial judge of inflation; take a look around a grocery store in America and you will have realized that food prices have certainly increased a fair margin above CPI numbers. The CPI however is more greatly weighted towards consumer electronics, and these prices tend to go down by virtue of improvements in technology, which both reduces material costs to produce gadgets and make these more efficient and powerful at the same time; nonetheless, even if we were to assume that the numbers were correctly weighted, it should be noted that the velocity of money is extremely low. What this means is that although QE has created a large store of money, relatively little has been loaned out. There are a number of reasons for this, such as low investor confidence and possibly a lack of credible borrowers. Regardless, this large accumulated store of funds may be best portrayed as an enormous tsunami of capital poised over the consumer market, waiting for an appropriate time to suddenly flood the system and cause systemic inflation. Although there is debate as to when this might occur, be it during a recovery when velocity increases on its own or when there simply are so much funds that banks start loaning out money willy-nilly, the funds must be released eventually and cannot be as easily sterilized as the Fed claims; the nature of buying treasuries with created money means the money has already been spent by the government and sits in the bank accounts of people who have benefited from said spending. Inflation may have been deferred, but its return is inevitable.

Second, the case for an improving economy is a fairly shaky one. Unemployment goes down, but the negative case (reduced number of participants in the labor force, lower wages, fewer hours, reduced full-time and increased part-time) is often skimmed over. GDP is up in the second quarter by a good estimate, but you would have noticed that GDP for the first quarter was revised down for a third time (2.5 became 2.4 became 1.8 became 1.1) and there is some controversy as to how this had occurred despite the new method of calculating GDP, which if anything would have boosted these numbers. The scary thing? That the government had to resort to cherry-picking economic data points to arrive at a positive conclusion, when they could have tweaked the data from the source. If they had done so already, just how bad is the data?

Finally, here is my case for gold. If you were to look at a Comex price chart, you will have noticed an interesting pattern; large dips in gold price are hardly gradual and occur most drastically when resistance levels are breached. Personally, I prefer to think of these as "nice round numbers that lots of people place stop-loss orders on and are forced to start selling at once."

Another trend is visible as well: when prices recover to a point that is above the breached position, these new buyers do not create new stop-loss orders, (itself a sign that they do not believe that the market is dependable, due to the recent high levels of volatility and the relatively thin liquidity). This can be observed by the behavior of prices when these positions are breached again, as observed in the charts below.

As seen in the top set of charts, the price of gold plunged from 1333, until it was just below 1310, yet no further selling was triggered and price rebounded to where it had begun. The same trend can be observed in the second set, this time until the more important 1300 resistance level was breached, and the rebound was even higher than it had been before. For nearly a month, these patterns were observed over and over again, ever since the 1200 resistance level had almost been breached when gold had reached its bottom. Unless a breach below 1200 is observed, it seems unlikely that stop-loss orders will exacerbate any downward momentum. This also means that price rises, for the short term at least, will find more support if it were to recover lost ground. Further, according to an article by Adam Hamilton of Zealllc.com (See his chart below), short interest in the Comex gold ETF (the red line) is at a 12.3 year record high while longs (green line) are only at a 4.4 year low. This means that the price fall may be tied, at least in part, to the short gold that had been released into the market since 2013; short covering could be very large as a result.

Disclosure: I am long SBGL. 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.