Charts created using Omega TradeStation 2000i.Chart data supplied by Dial Data
I thought I would show once again the long-term monthly chart of gold to demonstrate that despite the recent drop the long-term uptrend for gold remains intact. The current drop could either be a test of those lows or even a sudden thrust to new lows. There remains potential objectives down to $1,150 zone based on the long pattern that played out between September 2011 and April 2013.There is no law, however, that says those objectives must be achieved. A test of the lows or slight new lows is also within the realm of possibilities. Currently, as this is being written, silver and the gold stocks have reversed from down to up on the day after new lows for the current move down. This could be potentially bullish.
So what has been wrong with gold? It is not as if the fundamentals have changed dramatically. The trend since 2001 has been up because the USA and the western economies have been printing excessive fiat currencies since the world was taken off the gold standard in August 1971. It should be noted that neither the private banking system nor central banks were fans of the gold standard. Gold is limited in supply and as such was a constraint to private banking system desire to grow and a constraint to the central banks in managing the monetary system.
Fiat currencies are, however, just a promise to pay from the government. In other words, fiat currencies are just another form of debt. They have no intrinsic value. Gold on the other hand has historically been a store of value. The use of gold (and silver and bronze) has been in use for over 3,000 years as money. Monetary and economic collapse of earlier societies were often tied to abuse of the currency. While the Romans couldn’t print money as is currently the case they were able to devalue their currencies by cutting the amount of silver in their coins. Cheaper and more plentiful metals allowed them to effectively flood the financial system with coins that eventually became effectively worthless.
The world’s economic powers are printing more money because of the huge amounts of debt that have accumulated. The odds of the debt of the USA, Japan and the Euro zone being able to repay their debt is no doubt zero. Consumers and corporations that become overburdened with debt just default and declare bankruptcy. Sovereigns also default as has been seen on numerous occasions. Spain, Greece, Ireland, Cyprus, Portugal and probably Italy all would have defaulted if they had not also been members of the Euro zone and using the Euro. In order for the Euro to survive as a currency, it was essential that these countries effectively be bailed out. But the bailout has gone array because the people have rejected the austerity imposed on them, turfed out governments and revolted on the streets.
The bailouts were effectively bailouts for the large banks that were considered “too big to fail”. The taxpayer became the defacto bailout. And the taxpayer paid in the USA following the 2008 financial collapse and in the Euro zone when the Mediterranean countries and some others failed. But the revolts against austerity have changed the equation. The bailouts are now to become bail-ins in the future with depositors at risk rather than the taxpayer. This has changed the equation. The April collapse in gold got underway following short recommendations from Goldman Sachs and some others and a threat that Cyprus might sell its small holdings of official gold totalling 13.9 metric tonnes. If Cyprus sold, it was feared that others such as Portugal, Spain, Greece and Italy might sell their gold as well. Cyprus has not sold its gold and does not intend to sell it and the other countries have stated unequivocally that they too would not sell their gold.
Governments in the western economies have pushed interest rates down to almost zero (and in some cases it is zero). The result is that investor’s get little or no return from leaving their cash in the bank or buying AAA rated securities. This is known as financial repression. The costs to government of even a half of percent rise in interest rates would add billions to their debt.
In order to obtain yield investors have to move to lower rated securities or chase the stock market. Chasing the stock market appears to have worked as it has been on a tear. But the stock market remains highly vulnerable recognizing that it is riding a wave of funds coming from the governments quantitative easing (QE) programs. That it has not benefitted gold and gold stocks has been a mystery.
What has overwhelmed the gold market is the wave of paper gold that hit the market in April starting with the massive offer of 400 tonnes of gold on April 15. This helped trigger the $200 price drop over two days. The sheer volume of paper gold being traded far outweighed a year’s supply of gold several times over in just two days. So why would they do this? Some believe this has been manipulation and while there is suspicion that it might be it is also difficult to prove. Something more likely is that someone large needs to buy gold and what better than to get it at lower prices.
Is there something to that theory? Again, it is difficult to prove. Consider, however, that Germany asked for its gold back from the New York Fed and was told they would have to wait seven years to get it all back. Seven years for 300 tonnes of gold? They sold more than that (in paper gold) in 15 minutes on April 15, 2013. 300 tonnes of gold represents roughly 7% of world global annual demand. Texas has also asked for its gold to be moved from the NY depository to Texas. Given that many believed that central bank gold that was leased out was actually sold into the markets over the years the delay on moving the German gold could be why the market sold down as it gives someone the opportunity to replenish their supplies at lower prices.
Possibly of bigger concern are the dwindling supplies at the COMEX and other depositories including the LBMA. Following the Cyprus bail-in there was a dramatic 2 million ounces of gold over a three-week period at the COMEX warehouses. The depository warehouses are running out of gold. This raises the spectre of potential default.
The result of all of this is that the drop in gold price rather than creating a massive panic and even bigger sell-off there was a wave of buying of physical gold particularly out of Asia. Physical gold was purchased in both jewellery and bars and coins. Premiums from dealers normally 3% over spot soared to 5% and 6% over spot. While the spreads have eased somewhat it is only from 6% back to 5% at Silver Gold Bull www.silvergoldbull.com. Because of the volatility, dealers are buying at spot less 5% or 6%.
Demand for gold has not abated although as the World Gold Council reported demand may have weakened but not substantially. The ETF’s saw a net withdrawal of about 180 tonnes in the 1st quarter of 2013. But demand for jewellery, bars and coins was higher particularly in Asia (India and China) but also in North America allowing gold for investment purposes to still record a solid 200 tonnes for the quarter. Overall Q1 2013 gold demand was 13% weaker than Q1 2012.Central bank demand exceeded 100 tonnes for the 7th successive quarter.
The long-term trend for gold remains intact. The long-term fundamentals remain sound. The only solution for the western economies is to print money (QE) and push debt issues down the road. It is a debt trap. The US needs to maintain the illusion that the US$ is strong. What better way than to create artificial demand for the US$ while pushing down the price of gold that had been acting as an alternative currency. The purchasing power of the US$ has been falling for years. This current uptick is not going to change that scenario to any extent.
Gold production costs are generally pegged at about $1,250/ounce so any attempt to push it lower could perversely have the opposite effect of constraining supply further. That in turn would sow the seeds of the next rebound. Gold has seen other times when it has fallen 20% or more. In 1975/1976, gold fell roughly 50% and pundits were declaring that gold would never trade at $200 again. Gold reached $850 in 1980 and while that was the high for the next 21 years gold never again traded at $200 (the low was $250). Gold fell over 20% during the 2008 financial crash and many declared that gold would never trade over $1,000 again. Gold recovered to $1,000 in roughly 6 months. This time gold has once again fallen over 20% and many are declaring that gold could fall even further to $750 and never again trade at $1,900. Until it does trade at $1,900 or higher, it is currently difficult to argue against that statement.
Gold has over the years proven to be a safe haven and a store of value. Say what one will but since August 1971, gold is up 3800% while the Dow Jones Industrials (DJI) is up only 1,600% (all before adjusting for inflation). The chart below shows how the US$ has lost purchasing power in terms of gold. In 1971, US$1000 bought roughly 28 ounces of gold. Today US$1,000 only buys roughly 0.7 ounces of gold. In August 1971, the DJI bought 25 ounces of gold. Today the DJI only buys 11 ounces of gold.
Until the western economies solve their debt problems and allow interest rates to return real returns rather than the current negative returns the price of gold should not fall too far. Gold may fall to $1,300 or even $1,200 in the short term but the long-term value of gold has been demonstrated over and over again. Today given market volatility and the ongoing programs of QE as governments attempt to monetize their way out of their massive debt problems one should hold only fully allocated gold either in funds that hold only fully allocated gold or in coins and bars. Holding paper gold like holding paper stocks and paper currencies could prove to be merely an illusion of safety.
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