Based on the May 24th, 2013 Premium Update.

The Wall Street Journal ran a piece delineating the two sides of the gold debate giving five reasons why the gold bulls are right and five reasons why the gold bears are right.

Here is the 5-point gold “Bull” case:

1. Fears that Cyprus may sell its gold have receded.
2. The exuberance in the equities market will fade as soon as there is a major correction and investors will turn to gold.
3. The monsoon season in India will end, the marriage season will begin and with it the traditional gold buying frenzy which will contribute to long-term demand.
4. Banks in India count gold as part of the bank’s liquid ratio. As the asset base of banks will grow, so will demand for gold.
5. Physical demand for gold is high.

We added a few more reasons that they didn’t think of.

1. Central banks in various countries are buying the dollar to lower the value of their own currencies. That’s a currency war.
2. Central banks are still net buyers of gold and we don’t see any signs of abatement.
3. Central banks are flooding more and more fiat money into the system. The more they do, the more it loses its value. Gold cannot be printed and there is a limited amount that can be mined each year. Gold is money.
4. Owning gold isn’t necessarily about buying low and selling high. Sometimes, it is about owning a long-term insurance policy.
5. We don’t see a balanced budget in sight. We are not buying the economic recovery and the “recession is over” story.

Here are the five-point “Bear” case.

1. The U.S. Fed could cut the stimulus sooner than later.
2. Investor sentiment for gold is poor, to say the least.
3. The U.S. dollar is strong which dampens gold’s appeal for other currency holders.
4. Indian gold demand faces risks in the near term before the wedding season begins.
5. There could be further liquidations of gold ETFs.

Regarding the first point, comments from Ben Bernanke to Congress last week suggested the central bank may begin tapering its bond-buying program in coming months. On Wednesday morning, stocks had rallied after the release of Bernanke’s prepared remarks, in which he said that premature tightening in policy could strangle the economic recovery. However, in the question-and-answer session, Bernanke said the Fed could slow the pace of asset purchases in the “next few meetings.” That comment sent the markets gyrating downwards making for a volatile and interesting day for precious metals. The sector moved slightly higher, then soared, stayed high for several minutes and then crashed with stocks following more or less the same path. The USD Index did the opposite. The Fed’s bond-buying program is one of the major factors underpinning the stock rally. There is no denying that there was a time when it directly helped gold. In Thursday early trading gold bounced back as the dollar fell sharply and European shares dropped after weak Chinese factory activity added to concerns about a delayed recovery. According to the Market Watch report, Thursday saw safe haven gold buying, something the yellow metal has not experienced in a while.

China manufacturing data issued Thursday came in weaker than expected, which is bearish for commodities. The fact that gold rallied in the face of this news suggests there was “solid safe-haven demand for gold Thursday,” according to MarketWatch.

Last month’s savaging of the gold price no doubt has left new gold investors shaken. But the reasons that led to the bull market in gold have not changed. If anything they are stronger than ever. Unless governments suddenly start balancing budgets, or unless central bankers suddenly stop printing money, there is definitely a good case for those who side with the gold bulls. But as of now, Japan and the US have embarked on a record quantitative easing policy. The speculators have been shaken out and gold has moved into stronger hands who have been buying up the physical kind to keep and to hold.

We think that the gold bull market will resume its upward trajectory shortly. It is, however, vulnerable to further weakness in the short run.

Having discussed gold’s fundamentals, let’s move on to today’s chart section to see how the technical picture of the yellow metal looks like. We will start with the very long-term chart (charts courtesy by http://stockcharts.com.)

Gold prices moved higher last week but from the long-term perspective the rally is really not significant. It is barely visible here as it seems to simply be the expected period of consolidation which we have written about in the May 20 Market Alert we sent to our subscribers:

[in 1976] there was a pullback in gold before it moved below the initial low. We could see this type of action shortly. If silver and mining stocks consolidate below their previous lows it will simply serve as a confirmation of the breakdown and an indication of further declines.

The very long-term cyclical turning point is now quite close and it still seems that a bottom will be formed relatively soon but it is not necessarily in just yet. The reverse parabola trading pattern remains, so the possibility of a sharp drop in price is still in place for the yellow metal. The next support level, the 38.2% Fibonacci retracement level is around $1,285 and could be close to the level where the bottom finally forms, but a sharp intra-day or intra-week drop below it, would not surprise us either.

Now let us have a look at two important ratios that show gold’s performance relative to other important groups of assets. The first one is the Dow to gold ratio chart which is a proxy for a ‘stocks to gold’ ratio.

Little has changed in this ratio last week and it seems that the comments we made in last week’s essay remain up-to-date:

Here, we saw an important breakout above the declining long-term resistance line. This has bearish implications for gold. (…) The next resistance level for this ratio is at 12.5 and with it currently at 11, declines in gold will surely be needed in addition to higher stock prices in order for the ratio to move this much higher (it seems that a move higher in the general stock market will not be enough for the ratio to move that high soon). The implications are, of course, bearish.

The second important ratio that we’d like to discuss today is the gold to bonds ratio. Let’s have a look then.

In this another important ratio for gold, some strength was seen last week. Overall, however, this is not enough to change the outlook at this time and the short-term trend remains down. The next support line is the 61.8% Fibonacci retracement level, at 3.79, more than one-half a point lower than Thursday’s closing ratio level of 4.31. This is also equal to the level of the 2008 bottoms in terms of the closing prices.

Summing up, last week a pause was seen in the decline around the level of gold’s previous bottom. This is what we expected as it is very similar to what was seen way back in 1976. History does seem to rhyme here and since back then a bigger decline followed this type of move, we expect to see the same once again.

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Sincerely,
Przemyslaw Radomski, CFA