An Important Pattern The Gold Bugs Should Be Looking For

| About: SPDR Gold (GLD)

Summary

SPDR Gold Trust delivers a useful tool to identify the current state of the gold market.

As a rule, during a bull market in gold, GLD reports the inflows of gold into its vaults; during a bear market, the opposite happens.

However, strong corrections in gold prices (during a bull stage of the gold cycle) deliver quite a different pattern.

In this article, I am presenting a thesis that this, a little bit counter-intuitive pattern, may help to identify the end of each strong correction in gold prices.

In my last article on gold, I presented a thesis that not all things were bad for gold bugs. As an example, I introduced the so-called gold dollar index. In this article, I am discussing a pattern, which, in my opinion, is a prerequisite for the last stage of each big correction in gold prices.

SPDR Gold Trust

The SPDR Gold Trust ETF (NYSEARCA:GLD) is a very useful tool to track the performance of the gold market. As a rule, when the gold market is in its bull phase, investors are accumulating gold and GLD reports an increase in its gold holdings. During a bear market phase, the opposite occurs. Investors are reducing their gold holdings and GLD reports less gold in its vaults. However, during serious corrections, GLD sends very important signals that stand in opposition to the general rule. Because I believe that we are currently in the bull stage of the gold cycle (which started in January 2016), below I am discussing two examples related to this stage of the gold cycle.

Example 1: 2006

The chart below shows the pattern delivered by GLD in 2006, during a big correction in gold prices:

Source: Simple Digressions and GLD data

To remind my readers - in 2006, gold was in its fifth year of its great bull market, which had started in 2001. Between May and October 2006, the gold market encountered one of the biggest corrections since the beginning of the bull cycle. Until October 2006, the price of GLD dropped by around 21% (look at the points "A" and "B" marked in red) compared to the last top (printed in May 2006). However, during this correction, investors, instead of selling gold, were accumulating this metal. As a result, the amount of gold stored in GLD vaults went up (look at the points "A" and "B" marked in blue; the point "B" is higher than the point "A"). In other words, investors took the advantage of lower prices of gold and added around 28 tons of gold to their GLD holdings.

As everybody knows, after this correction, the gold market renewed and continued its march up.

Example 2: 2008

Now, let me discuss what happened in 2008:

Source: Simple Digressions and GLD data

This example is even more impressive. In 2008, during a serious financial crisis, many analysts and investors were wondering whether gold had ended its bull cycle. Between March and November 2008, GLD prices dropped by 30% (look at the points "A' and "B" marked in red). However, the amount of gold, held in GLD vaults, drew a totally different pattern. Initially, GLD's holdings also went down (the period between March and early May). Then, investors started accumulating gold. What is more, this accumulation was very impressive. Between early May and mid November 2008 (the end of that correction; the point "B" marked in blue), the amount of gold in GLD vaults went up from 580.5 tons to 749.0 tons (an increase of 168.5 tons or 29%)!

The title of the chart above is "GLD: 2008 bear market," but I think there was no bear market at all. The price of gold was going down, but physical holdings were going substantially up, as during a strong bull market. What happened then? Gold renewed its march up and gold bulls encountered another phase of the bull market.

How to identify the last stage of a serious correction in gold prices?

Let me summarize. These two examples deliver an interesting tool to assess at what phase the current cycle in gold is:

  • The general rule is: during a bull market in gold, investors are increasing their gold holdings and GLD reports the inflows of gold
  • During the last stage of a correction in the bull market in gold, investors start accumulating gold once again (and GLD reports the inflows of gold)

Now, let me look at the current state of the gold market:

Source: Simple Digressions and GLD data

Unfortunately for gold bugs, since early July 2016, despite lower GLD prices, investors have been reducing their gold holdings. Since July, as many as 113 tons of gold flowed out of GLD vaults (a decrease of 11.5%).

Well, in my opinion, it is not a very large outflow (the price of GLD has dropped by 14.4%), but the problem is that there is still no visible accumulation of gold reported by GLD. If I am correct and each strong correction in gold ends with higher GLD holdings, this correction has still some room to go. It does not necessarily mean that we should see lower prices of gold. The correction in prices may be extended in time, but the prices of gold may hold above the last bottom. What I want to say is that until there is no accumulation of gold reported by GLD, there are small chances to see the renewal of the upward trend in gold prices.

Disclosure: I am/we are long GDXJ.

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.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here