Gold Price Forecast: Gold Prices Set To Plunge?

There’s an old market saying that ‘when it’s on the front page of the newspaper, it’s too late’.

Certainly when some of the lesser qualified fairfax media reporters start running with stories like ‘Gold to run to US2000’ it could rightly be said it’s too late to get into gold.

One of my favourite summaries on this tendency is from Jim Leitner from Falcon Asset Management in the book Inside The House of Money;

“The thing that gets fundamental discretionary traders involved in trades is stories because we can grasp onto them. But, in general, it’s good to step away from the story and take it back to the numbers. Trading off a story is too amorphous. We need to quantify things and understand why things are cheap or expensive by using some hard measure of what cheap or expensive means. There has to be a combination of story and value.”

Well yesterday we saw gold prices start to tip.

The numbers

So what do the numbers say about where gold is sitting and where it is travelling? A quick glance at the RSI on gold (a good technical indicator of whether an asset is overbought or oversold) shows gold is way overbought but heading towards a more reasonable level.

Its huge breakaway from the 50 day moving average also indicates the numbers are saying sell.

 

Spot Gold Price Chart August 2011

Spot Gold Price Chart August 2011

 

Brokers obviously worried about the potential for a turnaround also were worried with CME Group making headlines a couple of weeks ago when it raised margins for gold trading by 22%.[i]

The path of the hot money

Commodities are full of hot money (money coming from trading on derivatives that allow huge leverage). This makes prices all the more volatile, and all the more capable of going into free fall. If you believe that we’re heading into stormier waters then history would show that hot money would typically flow out of assets in the following order.

  1. Copper
  2. Oil
  3. Risky currencies (AUD)
  4. Strong currencies
  5. Silver
  6. Gold

We saw something similar to this during the GFC with gold falling 24%, equities 32% and oil 36% from March 2008 to October 2008.

 

Chart of Gold Vs Equities Vs Oil, 2008

Chart of Gold Vs Equities Vs Oil, 2008

 

So we’ve seen equities being dumped, we’ve seen the oil price crash, is gold next?

Fundamentals

Yesterday Marc Faber (who famously picked the ’87 crash, the tech wreck, and the GFC) in an interview with Bloomberg shared his opinion on gold that “we will go down in a correction… Gold should fall $100-$150”.

When analysts who are slightly ahead of the curve (not fairfax media reporters) start to talk down gold prices you have to wonder that if the stories that drove the gold price up to begin with are starting to sour then can prices really go up more in the short-term?

The fundamentals reasons to hold gold are still there. Simply put it’s an asset that a central bank can’t devalue (unlike their currencies). Medium-term to long-term most analysts are still bullish on gold.

Gold Bears

Gold is a “bubble that is poised to burst.. We have seen the economic damage” of past bubbles and “feel compelled to ring the warning bells… There could be substantial risk to gold once the fear that the world is coming to an end subsides… We are worried about the downward risk”

Dean Junkans, Wells Fargo & Co. , August 15th[2]

Big players George Soros and Eric Mindich are also bearish on gold in the short term having cut holdings in SPDR Gold Trust (GLD) in Q2 2011. Perhaps a bit early on their cuts.

Buy the rumour sell the fact

The rumour is that the global economy is heading towards more stormy weather from the Eurozone and the US. The rumour on the front page of the paper is that gold is all that investors have left as a ‘safe haven’. The fact is in the short-term it’s overpriced.



References


[i] http://www.bloomberg.com/news/2011-08-11/gold-futures-margins-increased-…

[2] Gold Market Is a ‘Bubble Poised to Burst,’ Wells Fargo Says, Bloomberg, August 16th 2011