Interesting fundamental perspective on Gold

I found this very interesting article regarding gold and it’s fundamental driving forces. I agree with the points so much that I thought I’d repost it, as it essentially says a lot of what I believe about gold, written succinctly. This post was taken from Jake Honeycutt’s Kaching wall-posts page:

We seem to be in the midst of GOLD-MANIA! It's become the next real estate ... touted by everyone as a "can't lose" investment. Except, almost none of these same people make any appeals to its fundamentals and most seem to ignore the fact that it's been jumping upwards based on buying from three groups:

(1) Central banks
(2) Gold ETFs
(3) Goldbugs who believe hyperinflation is coming

Central banks have historically bought right before prices start to go down (which makes sense since they are the biggest buyers of gold and would force the prices to go upwards when they are buying).

Gold ETFs are buying like crazy only because more and more people are investing via them. But once momentum runs dry, there's going to be a big void in gold purchases.

The hyperinflationists have never had much of a coherent argument to begin with. A rise in sovereign debt does not mean a massive rise in money supply or inflation. In fact, the exact opposite has been true in Japan. I'm not saying that we won't eventually get high inflation here in the US; it's possible, but it's not going to be "hyperinflation" and the Federal Reserve will almost inevitably stomp it out once it starts.

More importantly, however, recent evidence suggests we are drifting back towards deflation and M2 money supply only increased 1.9% in 2009 --- hardly a sign of hyperinflation. If anything, it's terrifying b/c it might signal a return to deflation.


More evidence… this time it’s different

I posted yesterday why I thought that the market’s recent drop isn’t just another normal correction. Here I’m presenting further evidence that we may see 1040 before seeing new highs.


The chart above highlights the number of days it took to make new trend highs after each substantial correction in the past year’s bull market. Notice that each new leg up took 8-10 days to reach new highs. Compare that to now: we’re on day 12 since the low at 1040, and not even close to new highs. Also, notice that on the daily chart (as opposed to the weekly chart I posted yesterday), it is also clear that volume expanded on the downturn, and is shrinking on the upturn.

These facts tell me that the rhythm of this bull market has changed, and that the bear may be making a real comeback shortly.


This isn’t just “another 10% correction”

I’ve recently been seeing a prevalent view point about the market starting to sprout up, essentially that this past 9% correction is just like the June-July ‘09 correction, and that we should soon see new trend highs. I disagree with this view, and I’m betting that we’ll break 1040 soon.


Take a look at the /ES (S&P 500 e-mini futures) weekly chart above. Compare the volume on both corrections: the first correction had withering volume over 4 weeks, followed by equal or higher buying volume when the market blasted higher.

In the January ‘10 correction, we saw massively expanding volume on the downside, and withering volume on the upside progress. This tells me that the tide has shifted.

Even if we do make a new trend high, I will continue shorting into this strength based on the massive volume distribution we’ve seen. Good luck!


Why I’m Wary of the Gold Bull

Gold bugs are still raging. Someone mentioned that because gold has formed such a massive base between $700-$1,000/oz, it can’t go back down. Take a look at the charts below:


The first chart above is the Dow from 1974. In 2000, it topped out and dropped, but then recovered, forming a very strong base out of which is subsequently broke to the upside. Well, now we know that this base did not prove to be much in terms of support.


Now look at Gold’s chart since 1997. I believe we are in a 5th since the ‘99 low. You can see that gold formed a similarly massive base and has just broken out. I could see one more new high, but I think this base could prove to be very weak, too.


Potential RUT Head and Shoulders

Just to further entertain the ultra-bearish argument, I want to present this RUT chart that resembles a long-term pattern that I highlighted as possible on the Dow more than a year ago.

020810_rut_daily  You can see that the 2007-2009 bear market brought the RUT all the way back to the 2002 lows, and the bounced to the downtrend line. The decline was in 5-waves, and the rally was a triple-three corrective advance. If we were to retest 350, and then break this level, the head-and-shoulders projection would imply a further 59% drop to the 137 level. I would project 225 as more reasonable.

However if we did get a drop to 350, I would imagine everyone would be pointing out this head-and-shoulders, so we may get a fake-break that then leads to the next decade of bull-market growth.