Email of the day (1)
Comment of the Day

May 26 2011

Commentary by Eoin Treacy

Email of the day (1)

on the short to medium-term outlook for gold:
"Reading David's comments about gold it seems that we could expect further reversion to the mean, repeating what gold has usually done in the previous summer months, or we can see an upside acceleration to new highs. Last week Mr. Turk recognized that market was expecting a seasonal consolidation, but recalled that in 1982 when Mexico defaulted gold went up by 50%, even in the summer months. Do you think we could expect something similar, looking at Greece & Co.? If so, what would be the price action signals that we should follow? Thank you very much for your thoughts."

Eoin Treacy's view Gold has become remonetised in the eyes of investors so it is often instructive to view it quoted in other currencies. David reviewed gold in a number of currencies on Tuesday and found that the metal has assumed a position of relative strength against many of them. This supports the view that the secular bull market for gold has gained widespread acceptance among investors following a decade long appreciation. There are two points I believe are particularly relevant to gold at the present stage. The first is its seasonality. The second is its consistency.

Over the last decade gold has gone through relatively lengthy consolidations which have been completed by emphatic upward breaks that subsequently become overextended relative to the mean and climax with large downward dynamics. There has been a rhythm to this process with 18-month consolidations evident until 2010 and upward breaks in September of uneven years from 2001 to 2009.

This process has subsequently begun to speed up and we can use Heisenberg's Uncertainty Principle to explain how. By 2009 a growing number of investors were aware that gold had broken out of relatively lengthy consolidations in 2001, 2003, 2005, and 2007. When an increasingly large group of investors becomes aware of seasonality they move to anticipate it which changes the pattern. Logically, if we expect a breakout, we would prefer to buy before prices suddenly move higher and begin to initiate long positions. Gold broke out in September 2009 and rather than form an 18-month consolidation it broke out again in September 2010. It lost momentum from October, consolidated mostly below $1400 and hit another new high in March 2011. Periods of consolidation following breakouts have been getting shorter.

Let us turn to the consistency of the advance. Looking at this 10-year chart, the period from the 2008 low is clearly more consistent than the previous few years. Above all else this tells us that the medium-term dominance of demand over supply is becoming increasingly wide rather than contracting. Since late 2008, gold has moved into a consistent step sequence uptrend, where it has found support in the region of the 200-day MA on successive occasions and consolidations have been posted one above another.

A consistent trend is a trend in motion. Therefore, in the absence of a strong motivating factor, we can expect gold to consolidate mostly above the October - March range in a steady process of mean reversion. Gold and just about everything that is trending on a medium-term basis is best bought following reversions to the mean. If gold holds in the current region for a month or two, it would be reasonable to expect investors to begin accumulating long positions in advance of a September breakout. This could again speed the process up.

Yes gold did rally impressively in 1982 but short-covering following a more than 50% decline from the 1980 peak played an important roll in the advance. Nevertheless, gold is often viewed as a safe haven during a currency crisis because its supply cannot arbitrarily be increased. The Eurozone's sovereign debt issues are a potential problem but gold's bull market is wider than that single issue. For those worried about the purchasing power of fiat currencies gold is valued for its immutability. For those wishing to display their new found wealth gold is a classic sign of prestige. Perhaps most important of all is that global supply of this commodity has been shrinking relative to demand. All of these factors are helping to stoke what is already a major bull market.

The most likely scenario remains a relatively tight consolidation mostly above $1450. If gold is about to accelerate higher, a minimum requirement is that it hold above the early May high near $1577.

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