The Medium-term Outlook for the Yellow Metal

Sentiment towards gold is so low that you can scrape the floor with it. Two weeks ago gold exchange-traded funds suffered their largest outflow since January 2011 with gold falling on Friday as low as $1572.80. The world’s largest gold-backed exchange-traded fund, SPDR Gold Trust, reported its fourth successive daily outflow last Monday. The sell-off since the start of the year is mostly due to a perceived improvement in the global economic outlook and concerns on the longevity of the Fed’s quantitative easing.

Comments by top Fed officials made two weeks ago, suggesting the U.S. central bank could reduce or halt its asset buying had put heavy pressure on gold prices. Also two weeks ago, data released by the Commodity Futures Trading Commission showed hedge funds and other investment managers were shorting gold in record numbers. The number of bearish contracts held by professional speculators reached above 90,000 for the first time since mid-1999. It is ironic to juxtapose that with the rosy picture 10 years ago this month when the number of bullish contracts held by professional speculators first broke above 100,000 contracts.

Investors without the qualities mentioned above – patience, endurance and fortitude – have already been shaken out of the market. The pool of sellers is dwindling into a pond.
Forbes Magazine ran an interesting piece this week quoting a Time Magazine article:
“To hoarders and speculators gold lately has had about as much luster as a rusty tin can.”
The article itself is a bit rusty. The Great Gold Bust ran in August 1976 right at the bottom of a 50% retreat in the 1970s gold bull market. It had been only 19 months since gold purchases became legal for U.S. citizens and, according to the article, “the price has fallen more than 40% from its peak of $198 an ounce. In three chaotic days of trading last week, gold fell $14 on the London market, reaching a 31-month low of $105.50 an ounce. Though the price recovered to $111 by week’s end, that is still a dismal figure for goldbugs, who not long ago were forecasting prices of $300.”

Wow. $300. It‘s almost funny to read today.

It’s often when sentiment is at its nadir that gold becomes turbocharged. After the Times article, gold proceeded to gain 750% over the next three and a half years.

Gold looked very good last Tuesday when it posted the biggest gain of the year, up 1.3 percent, on Bernanke’s reassurance of continued monetary accommodation combined with Italy’s uncertain political and economic future. Gold broke above $1,600 an ounce, extending its rally to a fourth straight day.  Italy’s problems raise uncertainty about the viability of Europe’s single currency. The unemployment rates for youths in Spain, Portugal and Greece are approaching 50% and that may spell trouble this summer. Italian elections failed to show a clear winner indicating that voters reproached the present government’s austerity measures. It also suggests political instability in Italy in the coming months. Flight-to-safety buying of U.S. Treasuries, German bunds, gold and the U.S. dollar became the thing to do. Bernanke delivered the central bank’s semiannual testimony to the Senate Banking Committee sending a strong signal that he backed the continuation of the $85 billion bond-buying program.

The market largely ignored a cut of more than $200 in the gold price outlook by Goldman Sachs, one of the top global bullion banks. The bank reduced its 2013 gold price forecast to $1,600 an ounce from $1,810, citing bullion’s recent price drop and an increase in U.S. real interest rates.

For those who have recently bailed out of gold it may have the allure of a rusty tin can, but for us, it still has its timeless allure, that special something that has made it a store of value for centuries and millennia.  To see what is in store for the yellow metal in the near future let’s begin this week’s technical part with the analysis of its long-term chart (charts courtesy by http://stockcharts.com.)

In the chart, we see that the RSI level is extremely oversold and at levels very similar to what was seen in 2008. At no other time in this bull market has the situation been as oversold. This is one good reason for considering long positions in gold as opposed to short.

We still see a continuation of two weeks ago when gold bounced off the declining medium-term support line and no breakdown was seen. Last week, back and forth price movement was seen but still no breakdown, so the situation remains bullish for the medium term.

Let us see how the situation looks like from the non-USD perspective.

Recall that in our essay from a week and a half ago we stated that the breakdown had been invalidated. Prices did pull back and rally last week, but overall, on average, the price in non-USD currencies is now clearly above the medium-term declining support line. The breakdown has been invalidated and the picture remains bullish.

Finally, let us have a look at gold from the British Pound perspective.

In this chart we have a situation even more bullish than in the previous one. The consolidation has continued, and prices are clearly above the declining resistance line. The consolidation began last October, and the situation remains bullish; prices are expected to move to the upside. It’s good to remember the saying that, “the longer the base, the stronger the move”. The consolidation lasted for a long time so the coming rally will likely be significant. The consolidation is exceptionally visible.

The reason a lengthy consolidation often leads to a significant rally is that many investors stay on the sidelines or continue to leave the market while the consolidation plays out. This keeps the consolidation in place to some extent until something finally triggers a move to the upside to signal that the consolidation is about to end. Then an influx of capital from the sidelines quickly drives the price even higher. With longer consolidations, more investors, and thus capital, is waiting on the sidelines and can fuel following move.

This is what we have on the precious metals market now – combined with discouragement. Since the fundamentals are on our side, this creates a significant potential, just waiting to be triggered.

Summing up, the long- and medium-term outlook remains bullish for the yellow metal and it seems that the long-awaited rally will probably begin soon. Most of this week’s charts remain bullish and indicate that the overall situation for gold is improving.

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Thank you for reading. Have a great and profitable week!

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Sunshine Profits: Gold Investment & Silver Investment Website