When I last wrote a few weeks back, I pointed out that it was not too late to buy gold, despite the tremendous run-up that we had seen. Trading approximately 1770 an ounce, 80 dollars higher than when I made that suggestion, I continue to believe that it is not too late. The gold trade is now entering a new phase, but the macro headwinds should continue to be supportive.
I believe that one of the most difficult concepts to grasp for those not following the gold market regularly is that what dictates gold's performance is often in flux. Over the course of the last year, some people gave up on gold as an investment completely because it sold off in the wake of a very scary macro environment. The so called "fear trade" stopped working. It became clear that people would rather flock to US treasuries than gold as a safe haven. In retrospect, it makes some sense, because the main fear underlying the macro environment was based around the Euro. There is however a flaw in the logic of too many commentators who have argued that gold is dead because it does not react in a clear manner to the amount of perceived fear of global economic disaster. The reality is, that as the Euro has rallied, so too has gold. In the ultimate world economic collapse scenario, most everyone agrees that Europe plunges first, sending contagion throughout the world. Thus, were gold to perform based on the degree of fear in the markets, we should expect for it to trade with inverse correlation to the Euro. It has been the opposite. As gold has rebounded nearly 250 dollars per ounce from its lows just a few months ago, the Euro has only gotten stronger. The EUR/USD Cross which seemingly every currency trader was short below 1.25 is now sitting comfortably at 131.5.
So understanding that gold is not simply a fear indicator, what is it that has led the rally of the past few months? Naturally it is a combination of things. Technically, its breakout above 1630 (the top of the summers range) was supportive. Then came all the QE talk, and then, last week came QE. If the story ended there, then I would agree that maybe the gold up-move has run its course. But there are too many factors that remain supportive to gold, even without QE expectations to help push it higher.
Last week, as expected the Supreme Court in Germany upheld the legality of Germany's participation in the EU bailout funds. This will mean more money printing, which should, overtime, be supportive to the prices of hard assets such as gold. Somewhat paradoxically, such money printing should devalue the Euro, which given the recent trend (in Euro/Gold correlation), should be bearish for gold. However, bailout money and printing have served to make the Euro stronger. The reason as I see it, is that the Euro trade is and has been less about the relative amount of money being printed as it is the perception about the Euro's very existence going forward. While printing money dilutes the value of money already in circulation (and thus should devalue the currency), it increases the likelihood of keeping the European Monetary Union in tact. That has been the focus of the trade, and until that changes, such accommodation should remain supportive for gold.
I believe we are now entering the phase where the driver of gold prices over the next few weeks may be the degree to which violence persists in the Middle East. Months back, I wrote about how my friend had pointed out some articles on debka.com/ highlighting how much turmoil was present in the Middle East despite very limited American media attention. Sadly, it has taken murderous attacks and continued threats to our embassies overseas to get our news cameras to start rolling tape. Following the 2011 overthrow of Egyptian President Hosni Mubarak in February 2011, gold rallied steadily until it flew to make its highs just over 6 months later. Gold will tend to perform with other physical assets, and unfortunately, tensions in the Middle East seem a ways off from peaking. With oil sure to catch a bid with heightening tension, gold is also likely to come along for the ride. Given the speed with which gold prices have moved up in the last five weeks, a minor short term correction would be perfectly normal and healthy. With that being said, the macro environment continues to be supportive for gold, and I expect I will soon be writing about gold breaking and holding above 1800/oz.
