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Stress in the Gold Market

-- Posted Thursday, 25 July 2013 | | Disqus

By: David Chapman



Charts and commentary by David Chapman

26 Wellington Street East, Suite 900, Toronto, Ontario, M5E 1S2

Phone (416) 604-0533 or (toll free) 1-866-269-7773 , fax (416) 604-0557



Charts created using Omega TradeStation 2000i.  Chart data supplied by Dial Data


With gold headed to hopefully its first good up month in the past 10 months (setting aside a small gain in March 2013) it might be time to look at what happened at previous gold lows since the major double bottom lows seen in August 1999 and February 2001.


Besides the major lows of August 1999 and February 2001, other significant lows were seen in May 2005 and October 2008. The 2005 and 2008 lows came following either a lengthy correction or a steep decline. The actual lows were followed a month or at worst two months later by a sharp up month that left bullish engulfing candles on the charts. The up month followed the August 1999 low in September 1999, the February 2001 low in April 2001, the May 2005 low in June 2005 and the October 2008 low in November 2008.


Setting aside the 1999 and 2001 lows were at the tail end of a multi-year bear market for gold the 2005 correction lasted from November 2004 (the peak) to September 2005 (when gold took out the September 2004 peak) a period of 10 months. The market peaked in March 2008 and that level was broken for good until September 2009 a period of 19 months although the peak was regained initially at least only four months after the October 2008 low. Thus far, this one has been a lot longer. The peak was in September 2011 and has thus far lasted 23 months. Peak to trough the 2005 correction saw gold fall 9.5%, the 2008 correction saw gold fall 32.9% and the correction this time has thus far seen gold fall 38.1% peak to trough. Following the rebound this month gold is still down 31% from the September 2011 peak. These corrections occurred in what thus far has been a 12-year bull market for gold starting with the low of February 2001. The bull market is not over as many would like to declare as the major up trend line from the 2001 low remains intact.


To put this in some context the 18-year bull market for stocks from 1982 to 2000 had three major corrections in 1987, 1994 and 1998. The 1987 correction saw the S&P 500 lose 36% and last two years before the August 1987 highs were taken out. The 1994 correction only saw the S&P 500 fall 6.3% but it took the index a year to take out the January 1994 high. The 1994 correction for the stock index is comparable to the 2005 correction for gold. Finally, the 1998 correction saw the S&P 500 fall 22.4% but take only 6 months to recover the July 1998 top. Since then the S&P 500 has gone through major corrections from 2000-2002 losing 49% and taking until July 2007 to recover to the March 2000 high; and, a second correction from 2007 to 2009 that saw the S&P 500 lose 57.7% and take until April 2013 to recover the October 2007 top. Since December 31, 1999, the S&P 500 has had an overall (nominal) gain of 14.7% while gold is up 357% in the same period despite the recent correction.


Major bull (and bear) markets can last roughly 18-25 years. As an example, the Dow Jones Industrials (DJI) was in a major bull market from 1949 to 1966 a period of 17 years. Some believe the major bull market should be counted from the 1942 low and as a result, the bull market lasted 24 years. The bear market that followed was from 1966 to 1982 and lasted 16 years. The bull market lasted 18 years as noted from 1982 to 2000. The current bear market is in its 13th year. Gold does not have a long trading history but did have a bear market that lasted from 1980 to 2001 a period of 21 years. The current bull market is in its 12th year.


A possible characteristic of the major lows for gold over the past 12 years (14 years if one goes back to the 1999 low) is that the gold forward rate (or GOFO as it is known) went into backwardation at the 1999 low, the 2008 low and most recently. Gold in backwardation is a rare event. It is suggesting that there are supply problems in the gold market. It does not necessarily mean that the problems are going to be seen overnight but it is a negative sign. Gold in backwardation is like credit default swap yields rising even though there is no sign of stress yet in the credit markets. The emphasis is on the word yet. It is a negative sign that there is stress in the system that could result in an explosive upward move in gold prices. Using credit default swaps as an example the widening of spreads started in 2007 long before the financial crash of 2008. In 2008, the GOFO in backwardation in November quickly saw gold back at its March 2008 highs by March 2009.


Much has been made of the disappearing gold stocks at the COMEX. The chart below of the COMEX Depository Warehouse Gold Stocks  stress that appears to be going on in the gold market. Registered stocks have fallen precipitously from 3 million ounces plus in December 2012 to under 1 million ounces today. This is an unprecedented drop in supplies. Registered stocks are available for delivery. There are also eligible stocks (that have also fallen) but generally, eligible stocks are not available for delivery although they could. The disappearance of the COMEX gold stocks has largely coincided with the fall in gold price over the past few months.


Meanwhile the open interest ounces (futures contracts) to registered gold stocks ratio (number of owners per ounce) has reached record proportions taking out highs seen in 1999 and 2011. Currently at 46.79, that means there are 46.79 owners (or potential claims) for every ounce of registered stocks held by the COMEX.


The GOFO is in backwardation. COMEX gold stocks are disappearing. A claim on the remaining registered gold stocks has reached record proportions (number of owners per ounce). All of this is a sign of potential stress in the gold market and by extension stress in the financial system. It is a signal that someone(s) would rather hold gold than dollars. The gold market is highly leveraged. The GOFO rate has been negative for apparently three months. It suggests that holders of gold would rather borrow gold and use dollars as collateral rather than the other way around. The negative GOFO says that gold today is worth more than gold three months from now.


Demand in Asia has reached record levels. This is not to suggest that the COMEX gold has gone to Asia. The demand for gold has, however, caused deliveries in the London market to approach 100 days an unprecedented time to wait. Could a default be looming at the COMEX as some suspect? That too would be unprecedented.


Over the past year or so rigging scandals have been revealed in the LIBOR market, the currency market and the energy market. In many cases it is the same financial institutions that are involved. No one is convicted but large fines are paid with no admission of guilt. Many of the same financial institutions are involved in setting the daily London gold fix.


If gold prices hold where they are for the July month end it will leave a large bullish engulfing candle on the chart, a positive development. There are signs of stress in the gold market with gold in backwardation and the supplies disappearing at the COMEX. If these signs of a bottom in gold are correct then there is the potential that gold prices could rise quite rapidly over the next few months.


The charts of the COMEX Depository Warehouse Gold Stocks and the COMEX Warehouse – Registered Gold Stocks Cover are below.  






Copyright 2013 All Rights Reserved David Chapman

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-- Posted Thursday, 25 July 2013 | Digg This Article | Source:

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