Precious Metals and the Validity of Technical Analysis, Pt. 1


"Technical analysis shows a downtrending gold price but fundamentals are strong."

Recently, the economics site, Finance and Economics published an article, entitled 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. 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 this has wrong-footed many gold investors who found themselves waiting for a fall only to see it consolidate, and then rise.

Over the last few years, it has done this more frequently until we approach technical analysis in a way that allows for this and complements the fundamentals. Lately, 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 gold and silver prices is due to changes in the nature of the market, the type of investors, number of investors and the change in the location of investors.

Changing Nature of Gold Markets and Those that Aren't 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 early 1980–1999. Then European central banks agreed to cap sales under the Washington Agreement and the subsequent Central Bank Gold Agreements. Since the start of the sale of 403.3 tons of gold by the IMF (now completed), European central banks have ceased selling gold. The inception of gold exchange traded funds (ETFs) was another dramatic market change allowing a cheap and easy way into gold for institutions and wealthy individuals.

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

Often, what is not understood is that buyers of gold mining shares 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 itself 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.

Any 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 be far north of $2,000 by now.

The Change in the Types of Investors
In the early 1970s, investors in gold were wealthy individuals, institutions and central banks. Individual buyers were limited to coins, such as Krugerrands, the Gold Eagle and the like. Over the years up to 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 it imported from 500–600 tons of gold. Its record was 850 tons 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 ETFs were launched, U.S. fund managers (pensions, etc.) jumped in to buy more than Switzerland and China hold in their central banks. Currently, these funds hold more than 1,600 tons all told.

  • Physical gold funds popped up in Europe, BullionVault in the UK 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 bank's distribution capabilities. Now, Chin's government (itself, we believe, a buyer of gold for its reserves) has increased the number of banks allowed to import gold. Chinese demand is set to overtake India as a gold market this year. We expect its imports to add to the country's local production and together account for 550 tons of gold bought there. In 2011, we wouldn't be surprised to see this increase to 800 tons.

  • Even in the developed world jewelry market—the home of low-carat 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.)
Change in the Location of Gold Buyers
In the last few years, demand has spread from the developed world through the Mideast to India and eastward to China to become a truly global physical gold market centered on the London Gold Fix.

The drop in the purchase of gold mining shares to the shares of gold ETFs saw the developed world's institutions become indirectly physical gold buyers, as well. The market has realized that it's the physical gold market that counts. The added joy of this is that the corporate and mining risks do not accompany gold bullion.

So, today we are looking at a global physical gold market that is growing fast and fastest in China and India. 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 that found in the developed world.

Part 2 will cover global investors' changing attitude toward gold undermined technical analysis and why gold and silver are not in a 'bull' market.

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Legal Notice / Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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