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Struggling Gold!

 -- Published: Thursday, 9 October 2014 | Print  | Disqus 



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


It has not been easy being a believer in gold over the past two years. Gold is down about 37% from its 2011 top. The biggest portion of the drop took place over two days in April 2013 when gold plunged roughly $200 from $1,564 to $1,360 when someone dumped 400 to 500 tonnes of paper gold (futures) all at once on the COMEX. The collapse triggered an avalanche of stop loss or stop sell orders adding to the downward plunge. Percentage wise it was 13%. To put this in perspective the percentage drop was not as large as the 18% drop that was seen on January 22, 1980 when gold plunged from $825 to $682 as the 1976-1980 gold bull abruptly ended. 


Since April 2013, gold has tested down to $1,180 on three occasions. On June 28, 2013, gold fell to $1,183, on December 31, 2013 gold made a low at $1,182 and October 6, 2014 gold once again hit $1,183. A triple bottom? Triple bottoms are a rare pattern. Gold bottomed at $1,525 on December 29, 2011, at $1,528 on May 16, 2012 and at $1,539 on April 4, 2013. The market bounced for a few days following the April 4, 2013 low then crashed on April 12 and April 15, 2013. What some (many?) were hailing as a triple bottom turned out to be a mere fleeting moment. Triple bottoms seen so far apart are probably not triple bottoms.


Gold has bounced from that low but it is far from confirming that a low might be in. Three highs must be taken out to suggest that gold has made a final low. The first is the high of July 10, 2014 at $1,339, the second is at $1,382 seen on March 14, 2014 and the final one is the August 28, 2013 high of $1,428. Normally a pattern of declining highs and flat bottoms is known as a descending triangle. That is bearish and if $1,182 were to fall then there is the potential for gold to fall to potential objectives down at $1,025 or even down to $935.


If there was anything that differentiated the current pattern from the pattern that unfolded prior to the April 2013 collapse it was that gold instead made what arguably could have been a triple top. The highs were $1,798 on November 8, 2011, $1,789 on February 28, 2012 and $1,795 on October 4, 2012. The breakdown under $1,525 suggested a decline to objectives near $1,250. The actual low to date at $1,182 is not far from that objective.


The decline thus far is not far from a Fibonacci 38.2% correction. A 50% correction would take gold to around $950 not far from the potential objective noted above. A Fibonacci 61.8% correction would have gold at $775. Could that happen? Some think so most notably Harry Dent a financial newsletter writer/author. Ned Davis Research, well-known market analysts, have postulated that gold might be following its 1980’s pattern and fall below $700. Others such as Goldman Sachs and Robert Prechter of Elliot Wave International are suggesting a decline to at least $1,050. They seem almost bullish by comparison.


There are no shortages of gold bears. There are many gold bulls as well but they are quiet, chastened and ignored. Gold bulls have postulated that the current decline has characteristics of the 1974-1976 decline. Following the end of the gold standard in August 1971 gold rose from its fixed price of $35 to a high of $190 by December 1974. What followed was an almost 50% correction as gold fell to about $101 by August 1976. It was from those depths that gold began its ascent to the January 1980 high of $875. With inflation raging, interest rates rising, the Russian invasion of Afghanistan in December 1979 and the Iranian hostage crisis in November 1979 sending oil prices to $40 the background conditions were perfect for gold. People were lining up to buy gold as the forecasts were extremely bullish with crazy talk of gold to $1,000, $2,000 and higher.


Naturally that was the top as Fed Chairman Paul Volker hiked interest rates to 20% to turn the US$ around and helped crash gold. Gold bottomed in June 1982 at $337 down 61% before a solid rebound got underway taking gold to $514 by February 1983. Two years later by February 1985, gold was down to $281 about 68% from the 1980 top. Gold was not to make its final bottom until February 2001 at $255. It wasn’t until 2008 that gold finally equaled the 1980 high on a nominal basis.


There were no lineups around the block to buy gold at $1,900 in August 2011. Indeed the rise by comparison was quite orderly even though gold had risen from about $680 at the bottom of the 2008 financial crash. But with low interest rates and QE1 and QE2 coupled with sharply rising debt in the US and the US$ Index plunging from 121 in July 2001 to 71 in March 2008 the conditions for gold to rise were almost perfect. As high as gold was at $1,900, gold was still below its January 1980 inflation adjusted high. Today gold would need to reach $2,785 to equal the 1980 high. Right now that seems to be a distant dream. But it is possible under the right conditions.


To take gold lower is a mere matter of someone once again selling a large amount of gold futures as was seen in April 2013. Gold’s recent decline has been almost in lockstep with a rising US$ as gold generally continues its inverse relationship to the US$. There most likely will be the usual cries of manipulation and they may be right but it won’t matter in the face of a determined seller (or sellers) with deep pockets. Technically the series of declining highs since the August 2013 high and the rarity of triple bottoms appear to be pointing to a coming possible collapse. But the collapse is liable to be short-lived and if the wave counts from the highs of September 2011 are correct it would be the fifth wave down completing a possible Elliot five waves down pattern.


Let’s have a look at the worst case scenario being touted by Harry Dent and suggested by Ned Davis. While one can never say never the conditions that could send gold down to $700 do not appear to be there. The production cost of gold today is in the $1,100 to $1,300 zone. A sustained drop to $700 (or even $1,000) could push numerous firms into a loss situation and it is possible that mines could be mothballed and operations curtailed. There already is a deficit between demand and mine supply and a sustained drop in price could exacerbate the deficit. During the 1980’s, when gold did experience a 65% drop in price China was not a global economic power. China had little in the way in the way of gold reserves and was not, as they are today planning to build their gold reserves to the same level as the US at around 8,100 tonnes. China was not a major trading nation in gold in the process of setting up a major gold exchange in Shanghai.


Other conditions were different as well. The Fed rate has been held at zero percent since the 2008 financial crisis. During the early 1980’s the Fed rate was falling from a level of 14% in 1980 to 6% in 1985. The US government debt averaged around $1.3 trillion from 1980 to 1985. Today it is $17.6 trillion. US government debt to GDP today is 106% while from 1980-1985 it averaged about 35%. The US was a creditor nation not a debtor nation as it is today. Oddly, it was during the 1980’s that the US deficit started to grow. By 1992, the annual budget deficit hit $290 billion. Today it is about $600 billion but it has been falling since a peak of $1.4 trillion in 2009. The US monetary base was about $200 billion in 1985 vs. $4 trillion today. The US monetary base has grown from $950 billion where it was prior to the start of the 2008 financial collapse.


So what will it take to get gold to rise? In order to see gold prices rising there needs to be a loss of confidence in government. That would most likely come in conjunction with a falling US$. Right now there appears to be a preference to hold US$ rather than gold (despite the US$ pulling back over the past few days). Both the EU and Japanese economies appear to be falling back into recessions. The situation is the EU is potentially quite dire. Sanctions against Russia have a price. As long stated here sanctions are a form of trade war and are a lose-lose situation.


It is unknown as to what the trigger might be to see a loss of confidence. Two potential events stand out. First, an escalation of the wars in the Mid-East or an negative turn in the conflict in Ukraine and threatening conflicts in the East and South China Seas; or, a major bankruptcy that potentially triggers a global debt meltdown. In 1998, the Asian currency crisis and the Russian default triggered a financial meltdown (Long Term Capital Management (LTCM)) that almost brought down the financial system. Wall Street stepped up and saved the day. During the 2008 financial crisis following the collapse of Lehman Brothers, it was the Fed and the US government that stepped in to save the day. If there is another unknown event, it is Ebola. No one has any idea what a global pandemic might do the markets.


Since the world went off the gold standard back in August 1971, each successive financial crisis has been worse than the previous financial crisis (Financial crisis’s occurred 1973-1975, 1980-1982, 1990-1991, 1998 and 2000-2002 and 2007-2009). Each subsequent financial crisis was effectively bigger than the previous one and required more and more debt to kick-start the economy once again. It is almost a truism that the each subsequent recovery has been weaker than the previous economic recovery. The next debt crisis could overwhelm the Fed itself given the rising nature of debt crises. If that were correct it could result in a multi-year depression.


Since the gold meltdown in April 2013, gold has struggled. The range has been $1,182 to $1,428 with an average around $1,280. In theory gold could still go either way even as the pattern would seem to suggest that another sharp thrust to the downside is possible. If that were to occur, it should as noted earlier set-up a potential major bottom and the seeds of the next bull market. Gold bugs may require some further patience.


Copyright 2014 All rights reserved David Chapman

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The information and opinions contained in this report were prepared by Industrial Alliance Securities Inc. (‘IA Securities’). IA Securities is subsidiary of Industrial Alliance Insurance and Financial Services Inc. (‘Industrial Alliance’). Industrial Alliance is a TSX Exchange listed company and as such, IA Securities is an affiliate of Industrial Alliance. The opinions, estimates and projections contained in this report are those of IA Securities as of the date of this report and are subject to change without notice. IA Securities endeavours to ensure that the contents have been compiled or derived from sources that we believe to be reliable and contain information and opinions that are accurate and complete. However, IA Securities makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to IA Securities that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company.



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