Gold Chart Is Confusing At Best; Mixed Signals Blur Direction

by: Robert Wagner

I've been reading the SA articles trying to find a good argument as to why gold should go higher. While I haven't found a convincing argument as to why gold should continue higher, I have found it interesting that the bullish case being made also makes a bearish case. This article titled "What's the Game Changer for Gold" provides the bullish case.

Even with the tapering of the bond purchases that began in late 2013, the Fed's balance sheet remains on an upward trajectory and much higher than the price of gold. This suggests we should see much higher prices.

The case being made is that because the "Taper" only slows bond buying, the continued increase in the Fed's balance sheet should drive gold higher. The article claims that the correlation between the Fed's balance sheet and the price of gold is 0.95.

From 1999 through 2012, the correlation coefficient of the rising price of gold to the Fed's climbing assets was 0.95.

Problem is correlation does not prove causation. More importantly, just look at the chart. The Fed balance sheet is predicted to level out, and the recent sharp increase in the balance sheet did nothing to support the price of gold. In my opinion the causative factor of the increase in gold wasn't the Fed's balance sheet but rather fear. Fear greatly increased between 2008 and 2011, and now things are returning to normal. Fear drove both gold and the Fed balance sheet higher, and the calming of fears will drive gold and the Fed's balance sheet lower. This is an example of confusing multicollinearity with causation.

The other piece of bullish evidence provided is the price chart of gold. The fact that gold may be putting in a "double bottom" is the source of the excitement.

That too however is clear as mud. While gold does look to have put in a "double bottom," it has also formed a "head and shoulders" pattern, and the price of gold has simply rallied back up to its "neckline." To make matters worse, the 200 day moving average sits right around $1,312. Gold has simply rallied back up to where one would expect a "technical bounce" would take it.

Additionally, rates have started to move higher as have the equity markets. If the Fed continues to "Taper," I find it difficult to make a case for gold going much higher. Even the bullish cases make a solid case for the bears.

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Disclosure: I am long GLL. 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 also own calls on GLL