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What is going on with Gold? - Speculative frothChris Laird In the last couple of years, gold rose along with many things, oil, Mid East Chaos, the US housing bubble even. Now... Well, one thing is for sure, gold is weaker anyway. The feel is just not like it was these last gold bullish years, at least right now. I read 10,000 gold related news articles a year as part of my macroeconomic gold research. From that, one gets a 'feel' for what is happening. The feel now, the gestalt, is that the gold market has changed in a very fundamental way from the last few years. The reason for that change is two fold. One, the world economy is definitely slipping. Two, the speculative froth built into commodities and energy from unprecedented housing and finance bubbles in the past 5 years in the world is spilling off. Recent Gold Action Take a look at the recent gold action of past weeks. Following a month of horizontal gold price action between roughly 601 and 640, gold has slipped down past the 600 support, then to 580 support that held somewhat tenaciously until, now this week, we are looking at 570 support to give way. That has not happened. But we are looking at that. Every time gold has rallied at all, within the day, all the gains were given up. Reason? Speculative froth in the gold price built up for the last year is spilling off. Hedge funds and large macro funds are getting out incrementally. There is some base price gold is seeking which is lower than 580, right now. This gold chart is definitely not short term bullish:  The CRB index is also tanking:  A month ago, I started a string of gold short term bearish articles based on the premise that the world economy is slipping, the US in particular. -That commodities and gold would weaken significantly by Jan 2007. I got a couple of PO'd emails about that, that I am wrong etc. But, surprisingly, Prudent Squirrel subscriptions held up the same. I also got emails that many major gold analysts are saying the opposite of what I was writing, IE that gold was 'correcting', and ready to rally right away. As I have stated, gold is not 'correcting', gold is reflecting a major change in the world economy - to recession. OF course, that kind of made me think, maybe, I could be wrong that a short term gold bear was under way. It was not easy to continue holding to that view. But gold's price action of the last two weeks has confirmed my view. -Particularly the weakness of any rallies. Funds are selling into strength and just overwhelming any seasonal gold-bullish purchases right now. But gold's price action this last two weeks has confirmed my suspicions. First, every major gold rally in the day of the last two weeks was rapidly sold into. Second, gold rallied Wednesday, prior to the US Fed interest rate change window, in expectation of USD weakness if the FED paused. The fed paused, and the USD barely reacted... And gold tanked and gave back all its gains that day. Again, the gold rally was sold into. Speculative froth spilling off The speculative froth in the commodity and gold markets built up particularly since January 2006 is being spilled off. That is my assessment. The reason is that a consensus is appearing that -speculators and large macro funds are concluding that a US recession is now already underway, and is going to be commodity bearish - to include gold and oil. This will continue into 2007. China just recently had a monthly drop in oil imports. The US is not the only one having an economic slowdown. I very much expect that China is already responding to a slowing world economy, and in particular, to either their not insignificant monetary tightening of the last months, and or a peak of their industrial bubble. That has created large overcapacity - yes China now has overcapacity- in many key industries, such as base metal production like aluminum and other metal industries. And China already has a housing bubble that is crashing in Shanghai that is a year old already... And the US ? It has a weakening/crashing housing bubble, and rapidly growing corporate layoffs and very high insider selling of US stocks since the beginning of 2006. A crashing CRB Index, and Transportation Index. -All anticipating a severe US recession. Oil is seeing large increases in inventories, partly because of a mild winter onset in the US and mild hurricane season. The recent Ameranth hedge fund loss of $3 billion in gas, where they expected another bad US hurricane season, is a sign of recent times, IE a weakening commodity complex for different reasons. Sure, the hurricanes did not come, maybe they still will hit the Gulf. But that is not helping the CRB index either. A Weak hurricane season in the US and mild winter onset. Dropping demand for gasoline with those stocks rising in the US. Chinese oil imports actually receding last month for the first time in years... All are signs of a clear change in the world macro economic economy... to weakness... which is hitting commodities of all types, to include oil, and is causing a serious pause in the gold and commodity bull - by speculators at first, and then large macro funds- secondly. The reason we are seeing selling into gold rallies right now is that speculative froth is being unwound. Several years worth of that. There was an interesting article out about this of an interview with Peter Brooke, Peter Brooke is Equity Strategist at Old Mutual Asset Management: "Month to day resources is down seven percent, while the financial and industrial index is up one. So you can see how the selling has started to come through and one of the stockbrokers just quantified it, and they estimate is being about $12-billion worth of outflows in the last month. Primarily in oil, there have been $5-billion of outflows and about $5-billion of outflows in gold." "Bruce Whitfield: But certainly huge selling in these markets. Are these prices coming down for fundamental reasons? Are these just traders who are trying to make a margin? Is it that simple? Peter Brooke: I think the fundamentals are obviously the main driver, but what happens is, these speculators add momentum or power to the movement, so as commodities started doing well, through the fundamental demand from China and elsewhere and the lack of supply, traders and speculators jumped on that bandwagon and bought them up. And there has been about $100-billion worth of net flows into pure commodities. And that obviously absorbs more of the supply and pushes the price up. Now, if we see a reverse of that trend, it will add pressure on the downside and I think that just highlights the growing risk in commodities as they get to higher and higher prices, we start to see the potential for speculators to exit out or to take profits. " http://business.iafrica.com/transcripts/184482.htm Commodity prices unjustified by present weakening world economy The point is that there is speculative overhang in the commodities markets that is now unjustified by the emerging macro economic situation in the US and China to recession. Imagine a $5 billion outflow in gold in the last month. For gold, these numbers are huge. The gold market is actually very small compared to other markets. So, we know here speculators are getting out, at least the by scale of the liquidations, and this was last month. Where will this month, September, come in? So, we can see why gold dropped from $640 to below $580. As of Wednesday, gold was giving back all the gains earlier in the day. There is more of this to come. Now don't panic, because the fundamental reasons for gold rises these last years are very much with us - the inflation of US, EU and Chinese currency well above their GDP growth - monetary inflation. For the Western economies, that money growth is about 9% a year, while the actual GDP growth is about 3% roughly. That is a 5% inflation of the money base over and above actual growth. For China, there are figures of actual growth of the economy of roughly 10% while money growth is in the 18% range yearly! But, while the longer term reality of fiat abuse is very much with us, what is the shorter term implication of risen interest rates and monetary tightening? Deflating asset and finance bubbles and recession It will be a deflation of asset bubbles and now commodities, then stocks will get it in the neck too. Deflating asset and finance bubbles means less consumer demand and less jobs which means less profits which means less demand for commodities which means less demand for gold short term - for speculation. The recent gold market drops have not even held up with renewed buying in Asia for jewelry- traditionally a strong time of the year now. That has picked up, but frankly let's do some math: A $5 billion outflow of gold translates (roughly) into, 8 million ounces of gold at $600 bucks. That comes to 260 tons. Of paper gold liquidation. Last month. That is overwhelming the seasonal physical demand. And what about this month????? That is why renewed jewelry demand for gold, which hesitated above 600, has not held gold up. There is massive speculative overhang in commodities and gold - in paper - which has driven up the prices, and now that the world macro economy is slowing, that speculative unwinding - in anticipation that the commodities boom is over for now - is dropping prices in all of them - to include oil and gold. I will hazard a guess that the speculative froth in gold is on the order of $100 in the price still. There is more speculative froth to come out of commodities, and gold is tracking this. Now, I am not saying that gold is going to drop $100 from where it is now, but I do feel confident to predict that gold will drop to between 500 and 550 by Dec 31, 2006. I hate to say this, but we could even get to below $500. Reason overall for this? - A cooling world economy, dropping demand for commodities, and oil, and spill off of speculative froth in commodities and gold that has built up in the last several years in a very different world economic environment. I have to point out that I am long term gold bullish. However, these issues above are causing short term gold bearishness. In spite of a string of gold short term bearish articles, Prudent Squirrel subscriptions are at their highest levels ever, and the cancellation rate is virtually zero - about 1%. I suspect the reasons for the ongoing success of Prudent Squirrel include my willingness to objectively observe the gold markets. Macro economic analysis has enabled me to clearly anticipate the changes in the gold market this year by a good measure. Chris Laird The Prudent Squirrel Newsletter is a big picture gold and economic commentary. Stop by and have a look. 321gold Inc |
