Darshan's Blog

Darshan's Daily Market Ponderings

New High For Gold - The Oil of 2009?

Wednesday 4th November, 2009

Hello all!

Alright I think I jinxed the market on Monday, by saying that this week would be exciting. Yesterday was dull! The only thing that really shocked anyone was that the price of Gold rallied $25. I monitor a lot of bulletin boards for gold holders - it's a great gauge for the madness of crowds. They read like a penny share thread yesterday. Everyone was euphoric and some were quoting the next price points to be $2000, $5000, $10000 and so on. Evidence of hot money jumping onto a momentum play, if I ever saw it. Other's pointed out the reason for the rise being the Indian purchase of 200 tonnes of IMF gold. However, this actually happened last month but was reported yesterday - more evidence of hot money entering a market without checking the facts. So clearly, yesterday's move has set a lot of punters on the road to pump money into gold. Great stuff - this is the story of oil in 2008, being replayed with the shiny stuff as the main character.

Well we all know the merits of holding gold, the two major ones being - as a store of value (a protection against inflation) and as a safe haven. Well let's take each of these cases and see if they apply to gold right now....

Well M3 figures for the USA and Europe, show broad money supply collapsing and the multipliers doing the same. So we can eliminate the inflation argument entirely. Of course, the gold bugs counter this with the argument that the liquidity from Quantative Easing will not be extracted before inflation kicks in. They argue that the annual production of gold, is far below the world s rate of monetary growth and therefore, an any inflation could cause gold to explode north. Well that's another flawed premise - because the liquidity could be extracted in time and even if it's not - the $1 trillion pumped in by the USA, is still far less than the reduction in broad money supply over the last two years. All in all, the credit contraction means that any money entering the system is merely replacing a portion of the money that evaporated from the system since 2007. So let's just get rid of the inflation argument.

So is it useful as a safety haven? Sure it is. However, look we've been through two rough years where global markets lost more than half their values at the worst point. Yet the price of gold actually collapsed by $300 last year, along with the destruction of all asset classes. Physical gold is a great save haven purchase but do go long on paper gold (either via ETF's or just betting on the actual price of gold) is a folly. I don't see the merits of being long paper gold when your profits are going to be in fiat currency. If you subscribe to the inflation argument that so many gold holders are throwing about, without any evidence from M3 figures - then profits in real terms are going to be worthless. Of course, I don't believe in the inflation argument but rather I am a firm believer of a deflationary spiral that we have not yet fully seen in action.

So if you must hold gold as a safe haven asset - then hold physical bullion. Although even that will be pointless, if things get as bad as the gold bugs expect. After all, you can't eat a gold bar and anyone with enough force, can relieve you of it. Time to think again Goldies. Now you may be saying - "Darshan price is all that matters - and price rocketed yesterday, so why should I not get on board?" Well I have an answer for this....

What people fail to realise is that two things happened yesterday that should worry those who are long gold - especially on leverage.

1) The USDX actually jumped up (Curiously it rocketed to $81 but that was busted by the exchange and the official high for the day was recorded as $77.50 - very odd) - and this should have seen gold fall.

2) Silver did not join the gold party.

Now while some might argue that point number 1, shows gold decoupling from the dollar - I actually call it "non-confirmation number 1". The silver divergence just adds to this theory. More importantly, what people fail to realise that the actual high in real terms was back in 1980 and gold would have to reach $2000 an ounce to match that. If things are so bad and if the inflationary forces are so high, then why are we not near that price already?

Remember, I had three price targets - $1030, $1050 and $1100 before reality kicks in and we start a fast descent towards $500 and below over the next year. I'm still sticking to this. Everything I have said above confirms to me that the price of gold is a pure anti-dollar play and it's just excess liquidity trying to find yield, that is causing the price rise. This will reverse just as hard as it went up and when the USDX does base - we could see gold tumble faster than you think possible. Remember in March 2008, Gold tumbled over $120 in less than a few days. That is how fast leverage can work against you. (Current figures show that longs outnumber shorts on Gold by 8-1!). So don't fall for this rise - I am now scaling in with shorts on Gold myself, so I am putting my own money, where my mouth is. Now I could very well be wrong and suffer a bit of pain in the short term but I am confident that this trade will be a winner over the long term. If I'm wrong, I'll pay the price but hey that's what trading is about.

So Gold aside, what about equities today?

I can't see much action today in the markets, ahead of the FOMC statement tonight (2.15 pm EST). Although we do have the Non-Manufacturing ISM numbers out at 11am (EST), so maybe that can be used as an excuse to create a dip before the ramp. I do not expect any surprises from Bernanke and Co - as we know they are not wanting to raise rates, nor are they wanting to give us a specific time for exiting from the stimulus plans. So far they have injected over a $1 trillion into the economy and I'm sure we will get them boasting about how they have rescued the economy. So words are all they have for now...and for us, that's all we have to look forward to.

The Dow needs to lift above 9855 and the SPX above 1070, for us to reach higher levels that I expect to come next week - but we shall see how it goes. Right now the market just seems in limbo and I have a rule about not trading on FOMC days. Better to trade with a clear mind tomorrow.

Good luck for today!

Happy trading!

Darshan

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