Market Overview

Five Reasons to Buy Gold in 2014


There is no question that gold was one of the worst performing assets in 2013, putting in a horrible -28% return (first down year since 2000 and largest drop since 1981), due to growing confidence in the US economic recovery, and expectations of Fed tapering of QE.

It is possible that this year could be the second negative year for gold, but it is more probable to be a positive one as the stock market bubble unwinds and gold rallies off the double bottom and strong support of 1180 to reach 1400.

Here are five reasons for taking long shots at gold this year:

1) The stock market is a bubble waiting for a pin and gold is the bargain safe haven ready for a rally

Let's face it, the global stock markets are currently in a giant bubble goosed by the aggressive monetary policies of the Fed (0.25% interest rate + $85 bn/month in QE) and even more aggressive monetary policy of the Bank of Japan (0% interest rate + $50 bn/month in QE). For 2013, the Dow Jones rose from 13500 to 16500 (25%), while the Nikkei 225 rose from 10500 to 16200 (54%).  Now both markets are at dizzying heights, waiting for any pin to bring them down.

Recall: the systematic cutting of rates over the last 33 years to the dramatic lows of 1.75% in 2001 and 1.25% in 2002 reshaped the US economy into one big credit bubble, drowning its citizens and government in debt, and after this bubble burst in 2007-2008 after rate hikes and toxic mortgage debt revelations, the remedy for the collapsing debt bubble was more of its cause -- even lower interest rates near zero and when that didn't quite work, aggressive fed money printing (QE).

While QE has not helped main street it has helped wall street: it has worked to re-inflate the stock market bubble to even greater heights than it was before 2008, but the new pin on the horizon might not be the hiking of rates but the tapering of QE, sending wall street into withdrawal.

Some signals of stock market doom. There is an old Wall Street saying: "as goes opening day, so goes opening week, so goes January and thus so goes the year." On Thursday, Jan 2-2014, the S&P's initial trading day of the year closed down 1%, its seven-worst opening day percentage loss in 35 years. Recall that the S&P closed down in the first day of 2008 and that year had clocked a -49% low.

Here is another interesting observation from Tom McMellan of the McMellan Market Report, who explores a fascinating price pattern analog uncovered by the legendary analyst Tom Demark on how the recent stock price movement looks a whole lot like the lead-up to the 1929 top: 

"One very interesting implication of this chart pattern analog is that it says that the equivalent of the Sep. 3, 1929 top is ideally due Jan. 14, 2014.  No one should take that Jan. 14 date literally, since I could have slid the pattern alignment fore or aft a few days and it would still look good.  And the market tends to only approximate the 1929 pattern rather than repeating it precisely.  In other words, expectations of precision are just not warranted.

.....the Jan. 28-29, 2014 [Fed] meeting is a greater possibility for finding out that the markets may have to start to quit the QE addiction.  And the FOMC's March 18-19 meeting fits right about where the Black Thursday crash of 1929 fits into this analog."  Read More...

Oh what fun it is to play with these price analogs to predict the future stock bubble pop.

If the stock bubble were to correct this year, where would the investors flee? They might flee to the two well known safe-havens, US Dollar and Gold, by the the degree they are judged to be an attractive bargain.

Back in 2008 when the Dollar Index had fallen 40% over the previous 6 years from 120 to 71, it looked more like a bargain due to its dramatic 40% fall. Its safe-haven status and bargain level made it a winner for 2008, bouncing back from 71 to a high of 87, or 22%, though it ended 2007 at 82, or only 11% up. But in the last 5 years, the US Dollar Index has been forming a wedge pattern in the weekly charts, with support at 79.5 and resistance at 84, and it could very well remain locked in this wedge for a good part of this year.

Gold, on the other hand, looks like the bargain safe haven of 2014. Remember back in 2008 when investors were fleeing everything that looked like a bubble. Gold fell along with the stock market (though ended slightly positive for the year, unlike the stock market), because gold was then looking like a bubble as well, having gained some 199% over the previous 6 years from the 278 of Jan-2002 to the 832 of Jan-2008. But now that gold fell 28% in 2013 at the same time Dow Jones has gained 25%, a reversal could happen in 2014 on any bad news: the stock market would go down and gold would go up. We are back to the inversion that these two instruments have long held.

2) Dow/Gold Ratio at 2008 precipice level

When the stock markets go south, and gold is not in a bubble, investors park their funds in gold and wait out the storm, as illustrated by this 200 year Dow/Gold Ratio (how many ounces of gold it takes to buy the dow jones index): 

I think the perfect storm is now brewing, and we don't have to wait till the Dow/Gold ratio climbs back to 40, the level where it was at at the height of the Nasdaq bubble.

Why? The Dow/Gold ratio is currently in a downward trend that will end at 1.0 or below.

We are at Dow/Gold Ratio of 13.42 (Jan-2014), as seen in this 100-year Dow/Gold Ratio chart at macrotrends, and what I find interesting about this current ratio, when you zoom the chart from 1999 till now, is that it puts us back to the same level as Aug 2008, just before the massive sell off in the stock, currency and commodity markets:

If I plot the resistance level at 13.85, you can see we reached near enough at this level in December at 13.76, and now the ratio is dipping downward in January.  I believe that this is the year when the ratio will drop back down to 7.00 and below.

Back in the second half of 2008, it was the harder fall of the Dow relative to gold that caused the ratio to fall from 13.82 (Aug-2008) to 7.42 (Feb-2009). But this time the Dow/Gold ratio won't fall because of a stock market plunging harder than gold; it will fall from a stock market plunging and gold rising.

3) Bullish Speculation (Managed futures and ETFs) drops to record low while Commercial net short futures (Gold Producers) drops to record low

I am a big fan of sentiment indicators and I give you two of them.

Here is an interesting observation made by Tyler Durden of zero hedge regarding the bullish speculators (managed futures and ETFs) being record low on gold:

"While the last two days of relative excitement in the precious metals are noteworthy in their bucking-the-trend of recent months, there is perhaps a much more critical 'trend' that may finally allow the demand for physical gold to peer through the veneer of synthetic paper pricing.

As JPMorgan notes, speculative positions (defined CFTC net longs minus shorts) have dropped to record lows in the last few weeks. With ETF gold holdings back below 'Lehman' levels and gold coin sales elevated, perhaps the Indian government's (and most of the Western world's Feds) hope for the death of the precious metals market is greatly exaggerated...

Gold Spec positions at record lows...


This is a contrarian indicator: with investor sentiment so heavily negative, gold is ready for a rally.  

Ok, so the above is what the speculators like the managed futures and ETF players are doing with gold. They are abandoning it, which is a good sign, because it foretells a bottom.

But what about the gold producers: how are they positioned for gold?

Tom McMellan, editor of the McMellan market report, notices that the Commercial Traders Net Short position in Gold is at its June lows (when gold rebounded):

"The last time that commercial gold futures traders were actually net long at all was back in late 2001.  Since then, they have been continuously net short to varying degrees, and so the game consists of evaluating their comparative net short position.  The reason for that bias to the short side is that a lot of the commercial traders are the major gold producers who use the futures market to sell forward their future production.  Selling what you don't have yet makes you a "short" trader.

When the commercial traders were at this same sort of low net short position back in June 2013, that marked a nice price bottom for gold prices.  Now we are seeing the same sort of sentiment condition, and with gold prices retesting that June low.  Gold stock prices (XAU and GDM) have already broken below their June 2013 lows, as stock traders seem to be uniformly pessimistic about the future for gold. "Read More...

This is yet another contrarian indicator: when the commercials comparative net short position is at a low, it is time for a rebound.

My take on the combination of the two indicators above is: the dumb traders (managed futures and ETFs) are nearly giving up on being long gold while the smart traders (the commercials/producers) are nearly given up on being short gold.

4) Physical demand for gold very robust.

According to Bloomberg, "China’s consumption of jewelry, bars and coins rose 30 percent to 996.3 metric tons in the 12 months that ended Sept. 30, while usage in India, the second-biggest buyer, gained 24 percent to 977.6 tons, according to the London-based World Gold Council."

Also, there is projected rising purchases of gold before China's Lunar New Year festival on Jan 31, a date to take note of given that China is one of the biggest purchasers of gold

Despite gold futures 28% drop in 2013 (its worst since 1981), the WSJ reports that demand for gold coins shot up 63% to 241.6 metric tons in the first three quarters of 2013: 

Gold buyers, whether they be for jewelry or coins, hold their gold for decades and see the recent drops as a bargain buy opportunity.

5) Technically, daily momentum has turned bullish after the bounce off 1180 double bottom and strong support

There was clearly a bounce off gold in the later half of December, at the strong support of 1180.

This 1176 support has been confirmed numerous times in the last 5 years:

  • May 21, 2010: bounces off a close of 1176 to reach 1264 a month later
  • July 28, 2010: bounces off a close of 1162 to reach 1400 4 months later
  • June 28, 2013: bounces off a low of 1180 to reach 1400 2 months later
  • Dec 20, 2013: bounces off a low of 1186, then
  • Dec 31, 2013: bounces off a low of 1181...for the double bottom of December, to reach 1350 in 2 months?

Moreover, my own daily momentum strategy on gold turned bullish at 1238 on Jan03-2014:

The momentum strategy buys (sells) gold when the 19-period momentum crosses up (under) the zero line, and as you can see from the chart, momentum crossed above zero at 1238.

Price is now at 1225, which is a decent entry price for a long position. Anything in the 1200 to 1240 range amounts to a good long price for now and in the coming months. The initial target is 1350, and if momentum is strong as this level is approached, I might raise it to 1450 (the level reached by the last bounce off of 1176 in June-2013).

My exit plan, just in case I am wrong, is to exit when daily closes below 1180. Given that the last three bounces it has not been able to close below 1180, I can rest at ease that this is a stop that the big hands could not readily hunt for, in their attempts to flush out the gold bulls.

Case in point for flushing out early gold bulls: have a look at the Daily chart of Jan 06-2014, and notice that the flash flushing out of stops as gold sped down to 1210 after gold climbed to 1248. The banks undoubtedly saw a bunch of stops of the early gold bulls layered between 1210 and 1230 and they reached down to take them all out. After this flushing out, gold quickly climbed back up to where it was, forming a long tail. The banks know that the gold is heading higher over the next two months, and they want to shake the early climbers out of the tree.

Given the bubble in the stock market, the bargain in gold, the Dow/Gold ratio being where were in Aug-2008 before the slide in stocks, the stock market will probably burst sometime in the near future and gold will end up being the bargain safe haven. Contrarian sentiment indicators provide additional confirmation with gold bull speculation at record lows AND commercial futures short positions at record lows. All the while physical demand for gold is stronger than ever, and will become stronger moving into the Chinese New Year.

To top it all off, a double bottom has occurred in December 2013, which is also a strong support level tested in June 2013 and tested twice in 2010 --each time for significant rebounds -- and now it looks like we are in a rebound and rally up to 1400.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: Commodities Markets Trading Ideas


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