Sunday, March 3, 2013

Gold in the Time of QE

By Scott Silva

Within the last two weeks, the price of gold dropped sharply to levels not seen since July 2012 and nearly as low as the lows of December 2011. Spot gold lost 112 points in the ten days from February 11th to February 21st, a 6.7% slide.

Just prior to the selloff, many analysts identified an onerous chart pattern as well as a popular technical indicator that appeared to be turning bearish enough to reverse gold’s long standing bullish trend. The worrisome chart pattern is the bearish triple top. The indicator that anxious traders carefully watched for proof of a trend reversal to the downside is aptly named the “Death Cross”. 

The price of gold did fall in those ten days. But, did the bearish chart pattern predict a fall in the price of gold, or did traders create the patterns that confirmed the decline? 

A look at the market conditions surrounding the sudden selloff in gold shows the bearish chart pattern actually failed, and traders may have had more to do with the selloff than many observers might think.

First let’s examine the bearish triple top pattern, also known as the triple top reversal pattern.
We know the triple top chart pattern can lead to some powerful downdrafts, especially if the successive tops are separated greatly from support levels and the tops are spread over a long period of time. The triple top pattern occurs when price action meets resistance, falls, and retests resistance then falls, twice more.  The resistance level of gold recently is clearly established at 1805. The support level is also clearly evident; it appears as the bottom of a trading range. The support level is 1527. The three tops and the support level are evident in the daily chart for gold below. The depth of the trading range between resistance and support in this pattern is 278 points. A reversal occurs when price drops below support with relatively high volume.

But there are two elements missing in the bearish triple top pattern that are required to make the pattern valid. First and most obvious is the fact that price action has not dropped below the support level of 1527, although the drop came close. On February 19th, gold traded as low as 1554.30 but closed at 1559.60, quite a bit higher than the support level.  Price action has yet to close below the support level of the pattern.  Second is a lack of confirming higher relative volume, which may be moot without the breakout. Nevertheless, there is no sign of capitulation, or massive selling pressure. The conclusion is the triple top reversal in gold has not occurred.

But what did occur is a sudden selloff. What caused it?

The answer, in my opinion, is the power of the self-fulfilling prophesy. Traders believed that a selloff was coming and so they sold. Selling begot more selling, which continued until there were no sellers left, leaving the buyers in control. What did the sellers see coming for gold? It was the terrifying “Death Cross”, the bearish signal sent when the 50 day moving average drops below the 200 day moving average. It is highlighted by the circle on the chart below. Traders could see steady convergence in the averages days before the selloff. Then, just before the cross, sellers sold hoping to get ahead of the decline. And by selling, more sellers were alerted, all driving the bid lower.  The prophesy of a selloff became a selloff. It is a reliable phenomenon.  Traders with long positions set their stops at such junctions. And the shorts kick in at these points as well, hoping the decline will be deep. These sell long and buy short orders are made by humans and machines. Nowadays it’s difficult to tell which moves the market more.

The bullish trend for gold remains intact. We can make this statement because technical support has not been breached. In fact, the recent decline was healthy for gold. It has allowed some profit taking, and new buyers to enter at bargain prices. The major trend remains bullish for gold. Tuesday, Chairman Bernanke dispelled any rumors of gold’s demise, when he affirmed his commitment to continued Quantitative Easing, until such time as US unemployment shrinks to 6.5%.  The Chairman is referring to the administration’s favorite measure for the out or work. The true unemployment rate, the U-6 measure, is so much higher that it is deemed politically incorrect (a lofty 14.6% for January). At that rate of job growth over the last four years, the Fed will be buying bonds until 2035!

There is no doubt that more QE is good for gold, and evidently, stocks. QE is better for gold because gold cannot disappoint analysts and traders with lower quarterly earnings, which is one trap the ultra-easy monetary policy springs for stock market investors. Stock yields appear attractive compared to negative real interest rate fixed income assets. The Fed has distorted not only the yield curve but also the risk/return balance. This has pushed investors into stocks and in the stock indices higher. We are seeing companies manage earnings well while missing top line revenue expectations.  This is not a sustainable growth model for equities.  The model collapses as interest rates rise, and margins are squeezed further. Lower sales revenues are a symptom of recession in Europe, a slowdown in China and continued sluggishness in the US. QE Infinity is artificially pumping up stock prices. The forward PE for the S&P 500 Index, for example, is 17.90 compared to 15.78 a year ago. If there were true earnings growth, which only can be sustained by true revenue growth, the forward PE would be much higher.  Then, there is the $ 2 Trillion cash trove sitting on company balance sheets here and in overseas tax havens. Companies are not investing in growth. They would rather buy back shares and sit on cash.

So, how have investors fared in stocks vs gold during the time of QE? Since Chairman Ben and the Treasury began their ultra-easy monetary regime, gold has gained dramatically compared to
the broad stock index (SPX). 

No one can predict the future, including Ben Bernanke. But he seems intent on continuing his dovish ways. And as he does, those who own gold will be better off for it.

Responsible citizens and prudent investors protect themselves and their wealth against the ambitions of over-reaching government authority and debasement of the currency by owning gold. Gold is honest money. Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

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