Has the Gold Bull Market Ended with Friday’s Close
By the Curmudgeon with Victor Sperandeo
Price Action is Negative:
On the back of the stronger than expected U.S. jobs report, Gold fell 1.8% Friday, dropping below $1,200 an ounce for the first time this year. The yellow metal has dropped 11% from its July high of $1,345, thereby entering into a correction (defined as a 10% drop from its most recent high). It is also within striking distance of a four-year bottom at just below $1,180 an ounce.
On Friday, U.S. COMEX December Gold futures contract settled down $22.20 at $1,192.90 on heavy volume. Spot gold fell as much as 2% to its lowest level since Dec. 31st at $1,189.64 an ounce. That was its biggest one-day drop since this past July. Bullion's relative strength index is approaching its most oversold level since June 2013, according to Reuters.
The damage was across the board in the gold complex. The SPDR Gold Shares (GLD) ETF closed down 1.8% at $114.61. The CBOE Gold Index (^GOX) fell to its lowest level since November 2008 at $78.64, down 4.75% for the session. The Market Vectors Gold Miners ETF (GDX) fell 4.7%. Individual gold mining shares, like top rated Goldcorp (GG), were down about 4%.
Conversely, the U.S. dollar index (DXY) rose 1.2% to close at 86.64 (with an intra-day high of 86.75) - a four year high. It's on track for a 12th straight week of gains - a feat not seen in four decades. DXY's steady advance has caused broad declines in precious metals and other commodities:
· Silver was down 1.5% at $16.85 an ounce (source: Kitco) after earlier touching its lowest level since March 2010 at $16.69.
· Platinum dropped 3.5% to $1220 an ounce (bid price).
· Palladium was down 1.8% to $753.20 an ounce
Analyst Commentary on the Gold Price Decline:
Market analysts said that a strengthening U.S. dollar greatly diminishes gold's safe-haven appeal, despite economic weakness in Europe, China's continued slowdown, and numerous geopolitical hot spots getting hotter (Syria, Iraq, Yemen, Iran, Ukraine, etc.).
"We have a global economy that is not going anywhere, but we do have a strong non-farm payrolls report, and that appears to be enough to take down gold and discourage people from holding gold," said Axel Merk, chief investment officer at Merk Funds, which manages $400 million in assets in currency mutual funds and a gold ETF.
"What causes the big swings in precious metals is what investors are doing, and if the dollar is strong and U.S. yields are higher, then gold becomes one of the least attractive assets for them because it holds no coupon,'' ABN Amro analyst Georgette Boele said.
In his weekend newspaper column, Sy Harding, President of Asset Management Research Corp wrote Look Out Below for Gold. He notes that the U.S. dollar began spiking up in May as shown in the chart below:
"Meanwhile, the previous inflation concerns moved even further out of the picture. Recent reports of even lower PPI and CPI inflation in the U.S. and in the euro-zone have concerns rising that the real problem may even become global deflation. It also became more apparent that gold was in trouble when it was unable to rally to any extent as a safe haven in reaction to the growing number of global hotspots and uprisings in recent months."
"With our technical indicators, both short-term and intermediate-term, remaining on sell signals, I believe gold is headed lower. If so, it looks like next potential support is just under $1,000 an ounce."
Fed policy makers will scrutinize the jobs data as they prepare for the FOMC meeting Oct. 28-29th. Even though economists do not foresee an increase until around the middle of next year, the wording in the Fed's closing statement will be carefully scrutinized.
Several market watchers (like the CURMUDGEON) think that the Fed is way behind the curve after almost 6 years of ZIRP and QE. But in years and decades past, gold would rally even when interest rates rose, due to rising inflation expectations.
Analysis -Reasons for Gold's decline with a History Lesson on Gold as a Hedge:
"Gold has broken below $1200 and is heading to its previous lows ...." This is not surprising based on the sharp rise of the U.S. dollar (see chart below). The December U.S. Dollar Index Futures (DXZ) closed at 86.84 on Friday Oct 3rd. It had made an intermediate low the week of May 5th at 79.2 and since then is up a strong 9.6%. The previous U.S. Dollar Index bull market high was 92.63 in November 2005. We suggest that represents current technical resistance.
On Friday, the BLS "stated" (not necessarily real) a strong non-farm payroll number of +248,000. Non-farm payroll jobs for the previous month were revised up 31,000, while the unemployment rate declined by -0.2% to a post-recession low of 5.9%. This caused the stock market bulls to buy and shorts to run for cover. It also caused gold to decline mainly because hourly earnings were flat (-0.01) cent.
Flat wages means "no inflation" to the Fed and a possible postponement (?) of the interest rate increase expected for June 2015. However, the dollar bulls looked at the report as strong, and a likely rate increase sooner than for other currencies, especially the struggling Euro. In addition and importantly, OPEC is in disarray as the cartel is not in sync on oil supply or price as noted in this WSJ article.
The basis of virtually all commodities declining recently was the better than expected ("stated" - not necessarily accurate) non-inflationary growth in U.S. GDP of 4.6% as the final revised number. To many market participants, that implied rising interest rates next year, which resulted in a strengthening U.S. dollar and its corollary - weak oil prices. West Texas crude oil has dropped -15% from its recent peak of $105 with spot oil trading at $88 Friday and February Oil in backwardation (or discount) at $86.85.
Other factors contributing to a strong U.S. dollar include:
· Little or no economic growth in the European Union, with several countries nearing recession (e.g. Italy is already there).
· Sanctions on Russia as punishment of Mr. Putin's recent aggressions into Ukraine. “Sanctions and closed access to foreign-exchange liquidity from the West is feeding demand for dollars," said Dmitry Polevoy, chief economist for ING NV in Moscow.
· Continued sluggish Japanese economy and Abenomics have pressured the Yen.
Gold traded at $990 in January 2010, then rose sharply to a peak of $1910 in September 2011. With a closing low at $1192.7 on Friday, it's declined -37.5% in a bear market that's lasted three years. Commodities, as a whole, are in a four year decline. Therefore, this is a time to look for a bottom, rather than worry about the decline that has already taken place.
I believe Gold is a hedge to protect your net worth. It's not a trade (unless you are a professional trader). Therefore, a constant 5-10% allocation to Gold is deserved, in my view. If you realize that "81% of the global equity markets capitalization is supported by zero interest rates" set by central banks, this is certainly a logical deduction.
To illustrate Gold as a hedge, let's examine the period from the late 1920s to 1930s when the U.S. experienced true deflation and a depression. President Roosevelt's Executive Order [1.], announced on April 5th 1933 confiscated Gold from U.S. citizens on May 1st 1933. Therefore, only gold mining stocks could be used as a proxy for the yellow metal.
Note 1. Trashing the U.S. Constitution is a huge understatement of that executive order. The Supreme Court never heard the lawsuits. Why not?
Homestake Mining (HM) was the U.S. and perhaps the world's largest producer of Gold during that time. In the last quarter of 1929, HM traded at $8.50. Yet by 1931 it traded at $17 for a 100% gain! By the first quarter of 1936, HM traded at $68. (Keep in mind the official CPI dropped -19.77% from December 1929 to December 1935). After a dip, and split, it traded in the mid $60's throughout 1938 and for the first half 1939, before a bear market that lasted till the beginning of the fourth quarter of 1941 (the start of WWII for the U.S.).
It's important to note that the production costs are higher in most Gold and Silver mines than the current price. That will (sooner or later) become a factor that puts a floor under the precious metals. Unprofitable mines will be forced to shut down, which will reduce the total production of gold and silver and lower worldwide supplies.
With that in mind, gold is not expected to rally till the dollar declines, or a "material" geo-political event that escalates continuously and sparks demand for gold as a chaos hedge.
A worst case scenario for a sustained geo-political event is for ISIS/ISIL to move into Saudi Arabia. Much of the land they conquered in Iraq is on the Saudi border. To the east and south of Iraq there's oil production. Further south lies Kuwait, the Saudi oil pipelines, Bahrain, and Qatar. That's the oil and natural gas production capital of the entire Middle East!
Saudi Arabia recently started the construction of a high-security five-layered fence on the border with Iraq to protect the country from “infiltrators and smugglers,” according to state media. ISIS/ISIL has not been mentioned in connection with the fence. But it’s exactly the border with Iraq that’s being cordoned off.
With ISIS, Iraq and Syria uprisings a huge threat to Middle East oil production, gold could be a very productive hedge, indeed. In closing, I like what Kyle Bass of Hayman Capital Management says about gold:
"Buying gold is just buying a put against the idiocy of the political cycle. It's That Simple."
Till next time......
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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