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Is the bull run over?
As the FTSE pushes to five-year highs, gold has just had another torrid week. It is currently sitting just above $1,600, a level last seen in mid-2011 and some way off its peak.
So, the key question for investors is this: is it time to declare it 'game over' and bail out of the precious metal?
My analysis suggests we could reach a key decision point for the gold price before the end of March. Here’s why.
The gold price is stuck in a rut
I want to start with a chart that I posted a few weeks back. It shows the action in gold over the last two years. You can see that since the blow-off of August-September 2011, gold has been stuck in a range. $1,800 - the red band - marks the top of the range (resistance). $1,520 - the amber band - marks the bottom (support).
Since October 2012, gold has been moving steadily lower in a rather orderly fashion. This move is defined by the two blue tramlines. While some kind of short-term bounce looks likely, as we are sitting on the lower boundary of this channel, it looks as though we are now heading back down to test that amber area of support.
If that area of support does not hold - if, to put a round number on it, $1,500 is broken - then my theory that gold is forming a base before another one of its big moves higher is invalidated. It might even be time to move on from gold. Yes, that’s what I just wrote.
Is the great gold bull market over?
It wouldn't be the most poetic way for a bull market to end. I'd always envisaged some kind of triumphant spike up, perhaps even some official recognition of gold as a monetary asset, but, hey, I'm not in charge.
But hold your horses. Don't despair. We haven't even got to that $1,520 area yet, let alone gone through it. There's no guarantee we will even get there. Though it’s never too early to be considering what your exit strategy might be, it's too early to be declaring game over. There are a few things we can be very positive about.
Sentiment supports gold
Take sentiment. Being subjective, sentiment is notoriously difficult to measure. Some might see my own current hesitation about gold - given that I'm normally so bullish - as a positive contrarian indicator in itself. But just about every reading is at lows only normally seen at, or close to, market bottoms.
Mark Hulbert of Marketwatch notes that Hulbert Gold Newsletter Sentiment Index (HGNSI), which "reflects the average recommended gold-market exposure of a subset of short-term gold timers" has been -3.3% over the last four months. "You have to go back as far as 1991 to find another four-month period in which the average HGNSI reading was this negative", he says. In 1991, gold was $360 an ounce.
Bloomberg sentiment readings are almost as extreme. Its measure of positive sentiment – CMSEGSBL – stands at 32%. It has reached these levels before, but usually only at market lows – once in 2004, twice in 2008, 2009, 2010 and 2011.
Bloomberg’s measure of negative sentiment – CMSEGCBR – stands at 59%. It has only been this high three times – once in 2009, once in 2010 and once in 2011.
Baron Rothschild once said "buy when there’s blood in the streets". Sentiment is one way of measuring blood.
The relative strength index (RSI) is another. By measuring the velocity and magnitude of recent price movements, it attempts to show if a market is over-bought or over-sold. Gold’s RSI has only been this low three times in the last fourteen years. Last year, at the depths of the 2008 crash and at the historical low of 1999, better known as 'Brown's bottom'.
These kind of extreme measures suggest gold is a market that perhaps getting ready to turn back up. These are feelings associated with bottoms rather than tops. However, for now, the trend is down - and trends are powerful things.
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Is the equity market flashing buy or sell?
It's widely believed that gold and the equity markets trade in opposite directions. As one moves up, the other falls. You buy gold if you think equities are going to fall and vice versa. This is mistaken.
This chart shows gold and the S&P500 since 1981. Gold is in black, the S&P500 in red. I have marked with blue squares the periods when the two moved in different directions – in opposition. These periods were late-1984; 1988 to early 1993; 1996 to 1999; and 2001 to early 2003. With the exception of these periods gold and equities have moved in the same direction. Usually one has outperformed the other, but the direction has been the same.
Since 2003, gold and the SP500 have moved in the same direction. They have risen and fallen together with the fluctuations of the global financial markets.
Until last November that is. Over the last three months they have decoupled.
In summer 2011, they decoupled briefly - as is shown by the blue box in the chart below. Gold soared as equities tanked amidst panic over Europe. But they soon got back in tandem.
Since November however, gold and equities have decoupled. As stock markets have soared, gold has sold off.
I'm not yet sure what I draw from this. In the short term, of course, it indicates people are selling gold and buying equities. But what are the long-term implications? If equities carry on rising, will gold get back in tandem? If stock markets sell off, will gold sell off by even more? Or will it stay in opposition? Will the money that leaves equities as those markets sell off make its way into gold?
It remains to be seen how this will play out - but it is a development that warrants attention.
We all know the fundamentals for gold - even if the market is not currently delivering on them. They haven't changed. Governments are debasing their money and gold ‘should’ be the go-to asset in such an environment. (By the way, this is something that the virtual currency Bitcoin is proving to be. This alternative money is rising quickly in value – up some 500% in the past year as far as I can make out).
For now, gold remains in its multi-year consolidation pattern. But it looks like a defining re-test of that key area of support may be just around the corner. I will of course be updating you with my thoughts as this dramatic re-test unfolds. In the meantime hold onto your gold but also your hats – the next phase of the ride promises to be interesting.
• This article is taken from the free investment email Money Morning.
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Dominic Frisby