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Gold And The Fiscal Cliff

By  |  Commodities  |  Dec 30, 2012 10:14AM GMT  |   Add a Comment
 
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The price of gold has been hit by selling under concerns over the upcoming U.S. “fiscal cliff.” At least that’s what the news media’s explanation for gold’s decline has been. Here’s what Reuters had to say in a recent news article:

“U.S. stocks sold off late in the day to close at session lows on Wednesday as talks to avert a year-end fiscal crisis turned sour, even as investors still expect a deal….

“President Barack Obama and congressional Republicans are struggling to come up with a deal to avoid early 2013 tax hikes and spending cuts that many economists say could send the U.S. economy into recession.”

Now here’s the problem with trying to apply “rational” analysis of the news headlines in making gold price predictions: because the financial markets are by nature irrational and volatile, you can never, from one day to the next, know how the market will react to a certain piece of news or legislation.

For instance, doesn’t it make sense that if the U.S. falls off the fiscal cliff and a recession is thereby caused that gold would benefit from the safe haven inflows that would surely follow? Logic dictates that scared investors would transfer money from equities and into gold and gold equivalents to escape the punishment that paper assets would presumably suffer in a fiscal cliff scenario. But as we’ve seen all too many times in the past, the market isn’t always logical.

All of this is by way of preface to a point that I’ve made many times, namely that the best approach to gold is a trading approach which involves buying only when the technical conditions are clearly ripe for a rally. And we haven’t had a technical buy signal for gold lately.

Fundamental analysis, while helpful at times, is no substitute for a good technical discipline. That’s why gold with all its bullish longer-term fundamentals can be under selling pressure in the short term. It doesn’t really matter what the actual reason is; the only “reason” we need concern ourselves with is that right now there are more sellers than buyers. Until this situation reverses we’ll remain in cash and let the gold market sort itself out.

It has been reported that John Paulson’s hedge fund group holds $3.67 billion in shares of the SPDR Gold Trust (GLD). In July, gold-related assets of one of his funds comprised 44% of total assets. As one analyst has observed, “The big correction in the mining stocks has hurt his performance and reputation.” Businessweek reported that two of Paulson’s largest funds, Paulson Advantage and Advantage Plus, lost 36 percent and 52 percent in 2011. The two flagship funds are down 6.3 percent and 9.3 percent as of the end of May with losses continuing into July.

Paulson is a giant of sorts in the hedge fund world. He made a $25 billion fortune for his hedge fund investors during the 2008 credit crisis. Although Paulson is widely regarded as a true hedge fund king, his mistiming of the gold market has cost him dearly in the near term. While it’s very possible (I would even say likely) that Paulson will eventually be proven correct on his big bet on gold, the point is that you can be the greatest hedge fund trader on Wall Street and still get punished by Mr. Market for ignoring the short-term technicals in preference for the longer-term fundamentals. Technicals rule over fundamentals in the short term. Investors ignore this truism at their peril.

Now having said all this, there’s a chance that the fiscal cliff resolution could turn out to be favorable for gold. We’ll let the price and volume action of the gold ETFs speak for us, and a 2-day higher close above the 15-day moving average would speak very loudly indeed.

I note with interest that the aforementioned SPDR Gold Trust (GLD) is hovering slightly under its 150-day (30-week) moving average and is trying to re-establish support around it. Long-time readers of this report will remember the importance I attached on this longer-term trend line during the boom years of 2009-2011, for the gold ETF always respected the 150-day MA as the proverbial “line in the sand” during corrections in those years. During the entirety the 2009-2011 rally, the gold ETF never once penetrated the 150-day MA until late 2011 when the last bull swing ended.

GLD
GLD


Since then, GLD has fluctuated above and below the 150-day MA. It tried to establish a new long-term base of support above it in this past summer’s rally and is now testing this vital trend line once again. Note also the extremely high amount of trading volume in GLD that occurred between Dec. 18 and Dec. 20. This could be a sign of investor capitulation, i.e. a “selling climax,” which in turn would be a bullish sign for the interim gold outlook. I’d view as very favorable the prospects for a first quarter rally if GLD manages to get back above the 150-day MA next week.
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