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Gold Forecaster - Precious Metals and the Validity of Technical Analysis - Part 1

By Julian D.W. Phillips      Printer Friendly Version Bookmark and Share
Feb 11 2011 11:28AM

Recently the economics site:  published an article on “Precious Metals and the validity of Technical Analysis. We completely agree with the thoughts expressed there and in this piece would like to expand on their thoughts here.   Over the last eight years or so we have seen the Technical Analysis approach to the gold price give incorrect signals, when seen in isolation.  Many times the technical picture pointed down on the gold price in the face of a strong fundamental picture.  We know that this has wrong-footed many gold investors who found themselves waiting for a fall only to see it consolidate then rise.  Over the last few years it has done this more frequently until we find at the Gold Forecaster we approach technical analysis in a way that allows for this and complements the fundamentals.  Of late some analysts had identified a ‘head and shoulders’ top and forecast the end of the ‘bull’ market in gold and silver, but it has not come, nor do we expect it to come.  The reason the charts have failed so often to correctly forecast the gold and silver prices has been due to the change in the nature of the market, the change in the type of investors, the change in the number of investors and the change in the location of investors.

The Change in the nature of Gold Markets and those that are not Gold Markets

The traditional gold market comprised central banks and wealthy institutions and individuals in the days of the Gold Standard. Then ‘officially’ central banks left the gold market and started selling their gold in the market. The market was left to wealthy individuals in the main as miners and central banks worked together to undermine the gold price, taking it back from $850 to $275 from the early 1980’ to 1999. Then the central banks of Europe agreed to ‘cap’ sales under the ‘Washington Agreement’ and the subsequent ‘Central Bank Gold Agreements’. Since the start of the sale of 403.3 tonnes of gold by the I.M.F. [now completed] European central banks have ceased selling gold, to all intents and purposes.  

The inception of the gold Exchange Traded Funds was another dramatic market change allowing a cheap and easy way into gold by institutions and wealthy individuals.

The result of these two changes was to remove the central bank overhang from the gold market and to bring institutions and individuals into the gold bullion market in such as way as to affect the gold price.

What is often not understood is that buyers of gold shares in mining companies could never affect the gold price or bullion market. These shares were simply another set of equities. Many have and still do believe that the COMEX futures and options gold market affects the gold price. COMEX themselves will tell you that only 5% of the transactions lead to a movement of physical gold and where they do, the investor must clarify that he wishes to take or give delivery at the time of dealing. These two markets represented a huge amount of money involved in the ‘gold’ market that did not affect the gold market. To illustrate, a hedge fund recently closed $850 million’s worth of positions because COMEX kept increasing it margins payable. The fund is only a $10 million fund.

Gold ingots: Gold eyes all time highAny gold price linked or indexed fund, likewise does not involve the purchase of gold.  Indeed funds that offer shares ‘related’ to gold but not actually resulting in the purchase of gold bullion itself do not affect the gold price and are off the gold market.   Let’s be clear on this, if all these gold related investments were poured into bullion buying of funds or trusts that actually purchased gold against the purchase of its shares or certificates, the gold price would by now be far north of $2,000.

The Change in the Types of Investors

In the early 1970’s investors in gold were wealthy individuals, institutions and the central banks. Individual buyers were limited to coins such as the Krugerrand, the Gold Eagle and the like. Over the years until now there has been a dramatic change.

  •  In the U.S. individuals were permitted to own gold from 1974 on. Record volumes of gold coins were bought in 2010.

  • In India the gold market reforms did the same there and the Indian market burgeoned. Last year we believe they imported between 500 and 600 tonnes of gold. Their record was 850 tonnes in one year.

  • Central Banks have changed from sellers of gold to either holders or buyers, with the likelihood of them selling again fading into the distance.  

  • When the gold Exchange Traded Funds were launched, U.S. Fund Managers [Pensions, et al] jumped in to buy more than Switzerland and China hold in their central banks. Currently these funds hold more than 1,600 tonnes all told.

  • Physical gold funds popped up in Europe, the Bullion Vault in the U.K. and dealt for the small man. Gold buyers increased in number across the world.  

  • When China lifted the restraints on individual ownership of gold just over three years ago, the Chinese market exploded quietly in line with the spread of the distribution capabilities of the banks. Now the Chinese government itself [itself, we believe, a buyer of gold for its reserves] has increased the number of banks allowed to import gold. Chinese demand is set this year to overtake India as a gold market. We expect their imports to add to their local production and account together for 550 tonnes of gold bought there. In 2011 we would not be surprised to see this increase to 800 tonnes altogether.

  • Even in the developed world jewelry market, the home of low caratage jewelry, demand has recovered in the face of record gold prices to reach previous peak levels. [In the emerging world low carat gold jewelry is generally not deemed real gold.] in the location of gold buyers.

In the last few years demand has spread from the developed world across through the Middle East to India, eastwards through to China to become a truly global physical gold market centered on the London Gold Fixing.

The drop in the purchase of gold mining shares to the shares of gold Exchange Traded Funds saw the developed world’s institutions become indirectly physical gold buyers too. The market has realized that it is the physical gold market that counts. The added joy of this is that the corporate and mining risks do not accompany gold bullion itself.
So today we are looking at a global physical gold market that is growing fast, but at its fastest in China and India where the development of those countries is leading to a rapidly growing middle class that favors gold as an investment, but with a different attitude than found in the developed world.

 Part 2 to be featured in the Gold Forecaster, will cover; why the change in the attitude of global investors in gold undermined Technical Analysis and why gold and silver are not in a ‘bull’ market.

Subscribe through www.GoldForecaster.comor for silver].  

Julian Phillips,
11th February 2011



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