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Gold - Pausing Before The Next Advance
The Economy Remains Weak The housing market remains in a shambles and actually appears to be getting worse. Some of the measures of the housing industry are coming in at their worst levels in twenty years or more. For example, the recent U.S. pending sales of existing homes fell to its lowest level since the index began. This suggests it may take longer than previously anticipated for a bottom to be made in the housing market, especially since credit conditions within the housing industry continue to tighten. Recent economic reports in other sectors have not shown much improvement either. The employment situation appears to be getting worse, while retail sales are lagging, and yet gold and other commodities appeared to be walking on air in their meteoric advance, at least until this last March. Fed Speak and Reduced Demand All of this came to an abrupt end when Fed officials started to hint at the possibility that their series of interest cuts may be coming to an end. Although the FOMC did lower the fed funds target by 25 basis points at the April 30th meeting, their statement hinted at the possibility that they may be at the end of their interest rate cutting cycle. Higher interest rates, or in this case, the lack of further easing is the enemy of the gold bulls. These first hints of a less accommodative FOMC were all that was needed to, at least temporarily, halt the historic advance in gold prices. The U.S. dollar, which had been making historic lows against several major currencies, especially against the euro, suddenly found a renewed friendship in the Fed, as recent "Fed Speak" helped the U.S. dollar. This, in turn, dented the rally in the gold market. In addition, there were some signs of consumer resistance to high gold prices, especially in India, where consumption was curtailed dramatically. This is especially important since consumers in India buy about 25 % of the world's gold output. There are some estimates that Indian gold demand fell by as much as 60%. There were increasing numbers of Chinese exporters that are shying away from the U.S. dollar and attempting to conduct more of their business in Euros or British pounds. All of this hurt the U.S. dollar and helped the gold, at least for a while. Some of these policies are being reversed now, which is causing some additional long liquidation. International Monetary Fund Gold Sales The International Monetary Fund has decided to sell about $11 billion in gold reserves, which is the equivalent of about 13 million ounces. This proposed sale represents about 12.5% of their total gold reserves. Although this planned gold sale cannot take place until it gets approval from the U.S. Congress, the psychological impact of this much gold likely to come into the market is having, at least, some negative impact. This remains a short-term bearish influence on gold even though International Monetary Fund officials said "gold sales would be conducted in a transparent manner with strong safeguards to ensure that they will not result in any market disruptions." This is mainly a psychological bearish influence that will likely only have a temporary adverse impact. The Yield Curve Influence The implied yield curve, which is based on Eurodollar futures, is inverted until the July- August period of this year. A yield curve is inverted when short-term interest rates are higher than those of longer maturities of the same credit market instrument. The significance of an inverted yield curve is that, it is one of the best indicators of an impending economic slowdown. Between now and late summer, we can expect bearish, on balance, economic news. This in turn, implies less demand for commodities, in general, including gold. Gold futures are likely to have some trouble rallying due to this headwind of further likely weakness in the economy. However, the outlook for gold futures changes dramatically in the late summer period, based on our fundamental and technical analysis. This is because that whenever the yield curve changes from inverted, which represents a slowing economy, to normal, which represents a growing economy, demand for commodities normally increases. This "normal" yield curve reasserts itself in the late summer period of this year. An anticipated better economy near the end of the year should increase demand for commodities, including gold. Real Interest Rates With real interest rates at less than zero currently, which is inflationary, along with a stronger economy that is likely to emerge in the fall of this year, we will have the perfect storm for another major up leg in gold futures. While there may be some long liquidation in gold futures between now and late this summer, expect renewed inflationary forces to emerge later this year. This in turn, will propel this market to new historical highs, which are likely to take place next year.
Trading Strategy When late summer arrives, be ready to establish long term long positions in this market. We can expect the next bull market in gold to be a multi-year event. For more information on this article, I can be reached at 312.242.7911 or via e-mail at alan.bush@archerfinancials.com. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc. |
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In what appeared to be an attempt to defy gravity, gold made an historic move to the $1,030.80 level. This took place at a time when history has shown that many commodities, including gold, usually do not advance in price in times of economic weakness. When the highs were made, there was some talk that demand from hedge funds and exchange traded funds played a role in artificially and temporarily pushing gold futures to historical highs. There may have been some truth to this line of thinking, since strength in gold and other commodities took place for a long time after the first cracks in the U.S. economy were evident.
