What happened to gold prices?

December 6th, 2009

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On Friday, gold prices suddenly took a tumble of around 4% on high volume. The so-called narrative by the media of what happened goes like this (take care to read Mental pitfall: Narrative Fallacy):

  1. US unemployment data for the month turns out to be better than expected.
  2. Therefore, the US economy is on the way to a real recovery.
  3. As a result, Ben Bernanke is going to raise interest rates.
  4. Therefore, paper currencies are going to survive (one ‘expert’ interviewed for a media article really said that).
  5. Hence, gold got sold off.

There are many slight variations to this narrative. For example, “gold was sold because of a rebound in US dollars” or something like that.

But we take the media narrative with a grain of salt.

Firstly, the US unemployment figures are always fudged in the first place. In fact, this doctoring of statistics has enabled smart entrepreneurs to earn a living by setting up a web site (ShadowStats.com) selling non-doctored statistics. Secondly, the overall unemployment numbers showed a more disturbing trend, as A deeper look behind the jobless numbers reported,

The number of long-term jobless ? those out of work six months or longer ? is growing, while the number of short-term unemployed is declining.

In other words, the US job market is going through a worsening structural problem. That is, there is a growing mismatch between the skills demanded and skills supplied in the economy. As we wrote in Overproduction or mis-configuration of production?,

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments (see The first step in an economic slowdown?mal-investment in capital).

Our view is that even if the US government succeed in boosting employment by printing money (see Unemployment in Weimar Germany for an example of such) and cannibalising the private sector, it will be a sign of inflation, not prosperity. Unfortunately, the market often has the habit of being duped into thinking it is the latter as the sell-off in gold on Friday shows.

Next, is Ben Bernanke going to raise interest rates? We very much doubt so (see Permanently low interest rates for Uncle Sam?). At most, the Fed may do some token rate hikes to dazzle the market. But the main point is that the Fed Fund rate will remain low for an extended period of time.

So, will we be selling our gold? That depends on why we are holding gold in the first place. If (as we wrote in our book, How to buy and invest in physical gold and silver bullion) we are investing in physical gold bullion because of our distrust in the financial system and/or paper currencies, then there’s no reason to sell because nothing has changed.

But if we are trading in ‘gold,’ than that is a different story. To understand what’s happening, imagine a ship tilting to one side. As the ship tilts more and more, the pressure to rebalance into an upright position increases (any properly constructed ship should do that). In the same way, based on technical analysis, ‘gold’ prices are in highly ‘overbought’ territory. That is, the upward price momentum for gold is getting too high. More and more market participants are tilted to the long side of the trade. As such, a ‘rebalancing’ (i.e. correction) is overdue to get the momentum into a more balanced position.

But as in the ship analogy, there’s always a tipping point. If the ship tilts too much to one side, there will come to a point whereby its automatic stabiliser will not work and the ship will flip over. In the same way, if the momentum for gold prices keeps on increasing and go past a tipping point, it is a result of a currency crisis.

If you are a short-term trader in ‘gold,’ what should you do? So far, it is too early to tell whether this one-time correction signifies a change in trend (whereby US dollar will rebound for say, 3-4 months) or just a blip in up-trend. As we check out our cool Market Club charting tools, we find that Friday’s action barely touched the 30-day exponential moving average. In other words, so far, the up-trend still remains. But the thing to watch out for is whether the market will ‘believe’ that Ben Bernanke is going to raise interest rates (even though we all know such a ‘belief’ is ridiculous). If this belief gets entrenched, then we will see a temporary reversal in trend, which is a signal for traders to sell.

So, if you are investing in physical gold bullion because you want to sleep better at night, then Friday’s action should not concern you. If it still concerns you, then we recommend that you read our book, How to buy and invest in physical gold and silver bullion.

If you are trading in ‘gold,’ then you may want to hear Market Club’s technical update on last Friday’s action. Click here and check out the story under “2 Minute Video On What Happened To Gold Today.”

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