Gold: a chart perspective

by George Hatjoullis

Spot Gold (DFB)

The driving force behind Gold holding is as a store of wealth. The price reflects desirability as a store of wealth. As with all market determined prices, the Gold price is subject to ‘bubbles’ and one could conclude that the price performance since 2000 has been as bubbly as cheap champagne. However, beneath the bubble lay a genuine desire to hold Gold as part of the wealth portfolio. It is a demand based more on cultural norms than any fundamental property of Gold as a store of wealth but it is nevertheless a fact of life, more so in some countries than others. The period from 2000 to 2012 was one of financial uncertainty and concern over financial stability.

It is not simply a matter of inflation fear. Gold was also in demand when deflation was being discussed loudly. The reason was counterparty or credit risk. Individuals do not have access to central bank liabilities (except cash) and must use bank deposits as their store of monetary wealth. During the latter part of the period the soundness of banks came under scrutiny and holding bank deposits became overtly subject to credit risk. Individuals looked elsewhere for security and Gold was a beneficiary even though holding a commodity during a period of deflation is not really sensible. The other major asset class to benefit from the deflation fear was government debt, though mainly in nation states in which the central bank could provide an implicit guarantee for government debt. The return of normalcy to the financial system has deflated demand for Gold somewhat.

Inflation is not yet making a comeback and central banks have struggled to generate stronger inflation expectations. The proximate problem has been the banking sector and the inability/unwillingness to create credit. However, the problem may go deeper and reflect a surge in underlying global productivity and the inability of the market system to generate commensurate demand for the potential output. In the absence of strong inflation expectations or concern over credit risk, holding Gold becomes a little illogical and quite expensive. For the moment it is hard to see anything that will return Gold to the 2011 high.

Nevertheless, the Gold price has retraced a considerable distance. It has traded below the 0.382 Fibonacci retracement (1280) but not quite to the 50% retracement (1083). From a big picture point of view, the retracement may not be over. However, short-term the price is showing some buoyancy and this could presage a move up to 1300 (or even higher) on an intra-month basis. Given the background one would normally expect the price to fully retrace to the 50% level, but not necessarily from current levels. A bounce seems possible.