By David Rogers. April 23, 2017. BLOWING ROCK, NC — “Gold” is one of those investment classes that carries as much mystique as any other type of investment. Perhaps that is because of its long history.
In his Prologue to The Power of Gold (2004, John Wiley & Co., New York), Peter Bernstein tells of “…how people have become intoxicated, obsessed, haunted, humbled, and exalted over pieces of metal called gold. Gold has motivated entire societies, torn economies to shreds, determined the fate of kings and emperors, inspired the most beautiful works of art, provoked horrible acts by one people against another, and driven men to endure intense hardship in the hope of finding instant wealth and annihilating uncertainty.”
Rightly or wrongly, the world has shifted away from “the gold standard” when it comes to setting the value of national currency. And yet, gold still holds a firm grip on many investors’ respective psyches.
From a fundamental perspective, the price of anything is usually determined by the competing forces of supply and demand. Certainly that is true with gold. Before we get to our charts, let’s take a look at some of the factors influencing the supply and demand of gold.
- Inflation –– Higher rates of inflation in the prices of goods and services tend to push gold prices higher. Officially, the rate of inflation has been relative tame even if we are hard-pressed to find things that we buy cheaper in price, rather than more expensive. We believe that the steps taken by the Federal Reserve and the stimulus decisions made by the U.S. Government in the wake of the so-called Great Recession would have been highly inflationary in normal times. In reality, what they accomplished was fighting the powerful forces of deflation as the world’s economic systems were force to de-leverage themselves. Long-term, once that de-leveraging has fully run its course we suspect that the rate of inflation will accelerate upwards.
- Monetary Policy vs. Economic Data — At first glance, one might think that a strong economy would push prices of gold higher. Problematic to that view is the reality that gold, on its own, does not have a current yield, such as an interest rate affixed to a bond or a dividend payment from a common stock. So when interest rates are low, there is very little opportunity cost in taking on the higher risk of owning gold vs. an interest-bearing vehicle. As the economy strengthens, however, the Federal Reserve tends to allow interest rates to go higher, which also serves to increase the opportunity cost for investing in gold. Raising interest rates also serves to “throttle down” business activity, reducing upward pressure on the prices for goods and services. We are seeing the beginning stages of interest rate increases by the Fed. Will they move fast enough to offset the inflationary forces of a stronger economy with an inflated money supply? Time will tell.
- Uncertainty — Perhaps no time in the history of the world have there been so many forces potentially at odds with one another. Can the disruptive actions of the Islamic State in the Middle East be managed, if not eliminated? How will the prospective British (and potentially other nations) exit from the European Union turn out, both for the United Kingdom, as well as for the remaining member states of the European Union? How will President Donald Trump’s new, seemingly protectionist policies impact not just the U.S., but also the global economy?
- Supply & Demand Of Physical Commodity — Gold is bought as an investment in financial portfolios, but it is also used in the manufacture of jewelry and technology, such as in smartphones and medical devices, as well as dental uses. Demand in the technology sector fell 3% in 2016, while the world total demand gold in jewelry was down 15% during the last full calendar year. But investment demand, overall, advanced 70% in 2016, triggered by uncertainty over the U.S. election. Donald Trump’s election removed a significant element of uncertainty, at least as to who was going to be leading the country, but his post-election rhetoric often seems to change direction, or at the very least to alternatively soften or harden policy views, which adds to uncertainty. Purchases and sales of the physical commodity by exchange-traded funds (ETFs) are influenced, if not driven by investor demand. The Q4 profit-taking was not enough to temper the overall increase in demand, especially by ETFs through the first three quarters of 2016.
Let’s take a look at the long-term chart, at least in terms of a WEEKLY chart.
In our model portfolio we phased in purchases of NUGT, a leveraged gold-related ETF beginning in December as our weekly BRN Time Flex indicator ticked below -0.50, and took profits near the interim highs. Our sales were motivated by a risk management decision aimed at reducing leverage in our portfolio, but we also observed that prices were approaching the underbelly of a mini-congestion area of resistance, but then a more serious congestion area dating back to mid-summer and early fall (red circled area). We can also draw well-defined horizontal resistance (red dotted line) from the lower ranges of that congestion area.
The market for GLD pulled back from those interim highs, but have now surged marginally higher into the mini-congestion area and near the well-defined horizontal resistance. Based on this chart alone and our observation of emerging non-confirmations in our BRN Time Flex study, we might ordinarily think about establishing short positions in GLD, looking for intermediate- to short-term price corrections, but our DAILY chart says, “Not so fast…”
The most impressive feature of the daily chart is the strong On Balance Volume (OBV) shown in the lower portion of the graphic above. Although GLD price is approaching the aforementioned well-defined horizontal resistance and the lower end of the significant congestion area etched out last summer and fall, OBV continues to chug higher and seems to be pointing to higher prices. So rather than shorting GLD, we’ll hold off for now and maybe look to buy a short-term pullback. It may take some time, including significant periods of backing and filling to work through the congestion area resistance, but probability has increased that long-term trends have turned positive.
This report is for information purposes only. Nothing about the comments herein should be construed as a recommendation to buy or sell securities. Investment decisions should be made by each individual after considering available resources, liquidity, tolerance for risk, investment history, tax implications and other considerations after consulting with the investor’s professional advisor(s).