It feels like a long time since we have seen gold up nearly 40 dollars in a day. Making a high of 1579.8, gold was not able to quite make it back to the 81 level it had broken down from. I mentioned last Friday that I suggested a friend sell his GLD because gold trailed off below that 81 level late in the day. As such, trading action tomorrow could be critical for gold going forward. While we dipped as low as 1526.7 this week, a close near 1581 would make us nearly unchanged on the week... hard to believe.
As I write, 15 minutes before the stock market close, I am watching gold holding still at 1573 as the S&P makes new lows for the day. I think the persistent sell off in the stock market makes sense. The risk of contagion in the European banking system is being taken more seriously with every headline about deposits leaving European banks. I woke up today to read about how massive bank withdrawals were taking place in Spain, not just Greece. At a time like this, the "value investor" who snootily boasts of the great value they find in this market because they "take a long term view" has the potential to get crushed. Why is risk greater now than say 3 months ago? Has much changed? Not much and no, not really. So the cheap valuation shopper will use this as logic for why they are buying and not concerned with the erosion of their portfolios. I sure hope no such person would ever manage one of my portfolios, because they clearly miss the point about how perception drives the market.
Perception can be a self fulfilling prophecy. It does not matter if those who are withdrawing their life savings are being silly or shrewd. All that matters is that they are doing it. A few headlines here and there, and the run on the banks can happen so quickly that the situation can spiral before anyone can do anything to fix it. Let us not forget that there are a limited number of tools central banks have at this time as well. Cutting interest rates is hard to do when they are already nil. So stop looking at P/E multiples and comparing them to historical levels. Stop questioning if this is "sell and May and go away". And stop wondering if it is possible that the stock market can really continue at such a steep trajectory to the downside. It doesn't matter. The truth is, the cards are all in place for what historians might later incorrectly deem to be a "black swan" event. If you want to stick your neck out and try to buy the stock market, you well might see yourself up 8% in a very short period of time. But in my eyes, such a play has a very poor risk reward profile.
Why do I keep mentioning the stock market? Because it is the only thing that keeps me from being massively bullish on gold. Over 200,000 contracts traded yesterday (June futures), and gold was never able to even re-test the overnight low of 1527.6. Today, another 200,000 traded (this is very high volume compared to the last few months where you would often not see volumes exceeding 100,000) on a nearly 40 dollar up move. While one would be right to argue that yesterday's volume was on a down move, a closer look at the trading action yields a bullish signal. The lows from yesterday were made overnight, but the bulk (about 2 times as much) of the volume traded during the American session (8:20am- 5:15pm). During our session the range was not as wide, and as aforementioned, found a floor about 5 dollars above the over night lows. Clearly, there is no need to make the case for why today's high volume on an up day is bullish.
Looking back a few posts, I referred to futures trading as a losing game. I spoke to one trader I knew and he disagreed (he makes money). My thesis at the time was that the algos were working overdrive and making trading human vs algo (which is a losing game). The one thing that I recognized at the time that did not fit with my thesis was the volumes given the ranges. The ranges were not particularly wide, but you were still seeing strong volume. When ranges are wider, it stands to reason that stop fishing algos will be more active, because there are more stops for them to trigger. But by that logic, it doesn't make sense that the algos are accounting for the extra volume when the trading range is tight. So maybe there was some real positioning going on. Seeing the support yesterday tells me that trend might be continuing. The algos, were they having their way, would've pushed to see what stops they could trigger below the low. Their inability to do so indicates that there was real buying.
This real buying is why I believe the bull case is building for gold. The reason I do not think it is so easy to jump in, has everything to do with concerns that a lower stock market could lead to forced selling in gold for margin purposes. I am not sure if and what policy responses could be capable of stopping a bank run. And even if a bank run were to be stopped, I question what stimulative measures could possibly be enacted by both Euro countries and the US that would make people giddy about the stock market. If Goldman's Jan Hatzius is right then we will see QE3 at the next Fed meeting in June. But we have a month until then. Even if our fears are quelled about Europe, I do not see a catalyst that would cause a rush of buying other than the notion that again "risk is off the table and stocks are cheap". As such, I see continued risk to owning stocks, and consequently, short term risk in holding gold. That being said, I see no reason to delve into deep conversation about where to get in. It is better to let the market tell you. Anyone could buy at a random level and get lucky, but lets first see if gold can build a base. If we have more days like today, where gold and stocks trade in a near perfect inverse correlation, then we can decide that a pattern has been established, and re-initiate longs. But one day does not a pattern make, and I believe it makes more sense to wait until the gold market signals that it has stabilized before initiating longs.
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