Gold Price Collapse to $600?

By: Kevin_George

Investors never learn. Merely a year after the collapse in the financial system and the next speculative bubble is taking shape, this time in the form of gold.

Gold is now playing out exactly as oil did in its run to $147. Speculation and expectation grew until the mighty $100 mark fell. This breakout then hit the mainstream airwaves, with the usual segment of “How high can it go”. The calls came from Goldman Sachs ($150) and an executive at Gazprom ($200). At this point, the internet was rife with retail speculators asking, “How do I trade oil?” whilst pension funds began to embrace the “once-risky” asset class.

As oil began its descent, ALL markets came down with it. The chart below indicates why this was. Since 2002, the credit-fuelled run up in risk saw asset-allocation theories and fundamentals thrown out the window as investors chased yield at every opportunity. This created an “all assets vs the U.S. dollar” inverse correlation, which unwound in spectacular fashion, exacerbated by the fall of Lehman Brothers.

The sad part is that markets did not learn and the exact same trade has recovered on the back of rosy assessments for economic recovery. The arguments for gold will be the same as the arguments for China de-coupling towards the July 08 peak. This theory proved to be false

From a technical perspective, gold has made a strong double-top formation over the last two years and now looks ripe for a recovery to the mean. The liquidity that still remains from the era of loose monetary policy is still able to distort the technical picture and as with oil, breakouts may and continuation may occur in the near-term until real fundamentals, rather than fear and greed, catch up.

The support for gold is also based on inflation ‘fears’. This is a fair point, except that there is no inflation yet. It may come 1-2 years down the line. We are currently witnessing a deflationary spiral. Wages, house prices and consumer credit are falling. Money supply and CPI is falling. The recent ISM figures showed a 14% drop in the prices component over the month. The inflation risk is therefore priced in for somewhere down the line and this depends on strong economic recovery. As Japan showed previously, escaping from a deflationary spiral through money printing, can be a long and volatile process.

We therefore have a window of opportunity in the gold price, as the speculators have begun to push it higher. It may be 2 years until we see inflation. It may be 9 years before we see oil priced in a basket of currencies. The market is setting itself up for a “Black Swan” event, which will shake these growing assumptions to the core.

For example, Thomas Hoenig of the Federal Reserve said yesterday that the U.S. should raise rates “sooner rather than later” and that “1-2% was still accommodative”. If Bernanke were to raise rates to 1%, we would see the mother of all dollar rallies. As traders are now close to ‘net long’ records in risk assets, such as the euro and gold, any surprise to the market would see a brisk unwind.

By Kevin George

I am an independent financial analyst and trader.

© 2009 Copyright Kevin George - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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