*Looking at the prices of Gold, why it is moving and what lies ahead for precious metals*
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This week has seen the price of gold break through the $2000 per ounce price level and make new all time highs. In this blog post I am going to do a “deep dive” in to the gold precious metal market and look at current prices, the past few years of price action and talk about the fundamentals that influence this shiny yellow asset.
Gold has been on a strong bullish trend for the past 2 years since the breach above the $1200 per ounce level. Gold has also always been a good long term “investment” to have as part of a balanced portfolio and over time it is always believed to go up in value, the chart above agrees with this.
In recent years gold has seen some high levels of intraday/month to month volatility thanks to a number of fundamental and economic influences. Just in 2020 alone we have had the near miss of WW3 between the U.S. and Iran, as well as the coronavirus pandemic and now the increased fear of inflation. Before this year there was the Brexit dilemma and continued on/off tensions from the trade war between the U.S. and China.
It’s not just gold that has seen an increase in buyer attention in recent months thanks to economic and fundamental influence. The price of Silver has also found its bottom this year at around $11.58 per ounce before then climbing over 130% in value in the past 5 months.
Silver and Gold are both precious metals that are popular stores of wealth and used in luxury items like jewellery as well as in electronics and technology. Gold is naturally more expensive than silver and that does make it more attractive as a method of storing wealth outside of the higher risk stock markets/financial markets because it requires less room and less weight to store more wealth in dollar value. However, this year returns on investments in silver have beaten gold.
Looking at the charts shown so far it looks like precious metals are set to continue this bull run and continue to make all time highs. But for arguments sake, let me show you the monthly price chart for spot gold but with an indicator applied to the chart this time.
You may or may not be aware of what the RSI indicator is or what it means but it stands for Relative Strength Indicator. It uses past price values to calculate whether the current market price is over valued or under valued or…. over bought or oversold.
Before every significant correction in price over the last 20 years gold has gone above the “oversold” 80% level on the monthly RSI chart.
- In 2006, this breach of the 80% RSI level was followed by a 24% decline in the price of gold.
- In 2007, this breach of the 80% RSI level was followed by a 33% decline in the price of gold.
- In 2011, this breach of the 80% RSI level was followed by a 38% decline in the price of gold.
Is there potential to short Gold at these levels?
According to Goldman Sachs, gold is on its way to hit $2300 per ounce. This is their latest prediction for the precious metal. A lot of investment banks have been calling the break of $2000 per ounce but the upside targets vary widely.
- Commonwealth Bank of Australia predicts $2500 per ounce as a long term target.
- Bank of America raised its 18 month price target to $3000 per ounce.
I do think it is important to take these big Wall Street predictions with a pinch of salt because they are often made in hindsight when price is on a bull run and there is no impact from upside price targets being hit or not. These banks and analysts also tend to make a large number of price predictions in the hopes that one or two come true.
However, as seen time and time again, once an asset or security or even currency (bitcoin) reaches a milestone or all time high prices the news articles begin to get released and it starts to get the wrong kind of attention. This is when the next phase of a trade might occur.
The diagram above shows the hype cycle of a typical new company or technology and I think it can be used to perfectly describe bubbles in the financial markets.
The first phase of growth is caused by early adopters, believers in the tech and those who are genuinely invested in the future. In the case of gold this might be the long term buyers who are holding as an investment plan as part other portfolio. Then you get the active speculators who start to see price action showing bullish signs and they start buying in to the trends.
The price chart of gold currently looks a lot like we are in-between the rise and the peak phases of the diagram. Somewhere around where the mass media hype begins and look at what tends to happen next. You get the late buyers, the mum and dad investors and the postman and the shop keepers who are hearing and reading nothing but news about how gold has risen 30% in a year and is set to keep climbing to maybe even $5000 per ounce next year. This is the peak.
If you don’t believe this is the case then that is fine but do you remember how bitcoin played out?
Late 2018 was an interesting time for bitcoin and even if you don’t remember what the price of bitcoin did in that time you will certainly remember the constant media coverage on the matter and propaganda on how it was going to be worth $100k per coin within 12 months. And then as always, the bubble bursts and price soon begins to converge on its true value.
This links nicely back to what I spoke about in Fridays blog post last week when I was explaining an investing philosophy to you all. Many traders and investors who get burned by asset price bubble bursting do not follow this simple philosophy.
Do not fixate on the direction of price but instead focus on the true value. Look to go and buy one dollar for 50 cents because you know it’s worth is double. Don’t pay two dollars for a single dollar because you think it is going to be worth four dollars. This is the key to long term investing.
As you can see from the charts shown earlier in this blog, the current price of Gold does look more and more like an asset price bubble as each week goes by. These bubbles soon burst and leave late buyers licking their wounds. However, there are a few key differences between Gold and Bitcoin and other investments that have seen similar fates such as the majority of Internet start up companies in the DotCom boom.
Firstly, there is a real risk of inflation right now across multiple currencies. Central banks are running aggressive monetary and fiscal policies with large levels of fiscal stimulus and quantitive easing. This is increasing money supply and this is looking likely to continue for the foreseeable future. Second waves of the virus and restrictions that were eased but now coming back in to force are leading to increased pressure on global economies which in turn puts pressure on central banks and governments to keep printing to keep them afloat.
When the virus pandemic first hit the major economies of the world there was an initial fear that deflation would occur and this was shown in the data with U.S. annual inflation falling from around 2.5% to near zero in the space of a few months. However, there is a natural lag with this sort of data and the U.S. federal reserve and other central banks didn’t start their quantitive easing and money supply fiscal stimulus right away. Inflation has bottomed out and bounced a little last month and the fear now is it will go the other way… real fast.
Previously I spoke about how the U.S. Dollar is not as weak as people might think, and most of what I said in that blog post still stands true. If every currency is being devalued thanks to increased money supply then generally it will have a limited effect on the prices of currency pairs when traded against one another. However, when a currency is trade against an asset like gold, which has a limited supply and is not being mined at a rate anywhere near the rate of currency printing, then there is a real risk of inflation and this is partly why the value of gold has rocketed recently.
Secondly, global interest rates are at all time lows and even negative in a lot of countries now. This presents a problem for investors looking to place funds for returns in a global market where uncertainty is high and the future is still unclear. As I have previously spoken about in multiple blog posts, stock market prices are still unjustified in my opinion and more bankruptcy claims are continuing to come every week so the prudent long term value investors and big money managers aren’t looking to buy vast amounts of stocks right now. Gold and precious metals are therefore looking more and more attractive each day because although they are not income generating (no dividends), they are competing with fixed income investments that now also pay almost nothing in income. The value of Gold only needs to appreciate a tiny amount each year to make it much better than any other fixed income products.
How one can buy or sell gold.
Buying physical gold is very simple but it does impose risks that buying gold derivatives do not have. The main issue with physical gold purchases is the cost of delivery and then securely storing it. The other slight drawback is the lack of leverage available on physical gold purchases which can limit the returns on investment for investors with smaller funds.
Gold ETF’s, junior mining companies (businesses that extract gold from the earth and sell it) and futures/options contracts are all via methods of buying gold but they will all have their own benefits and drawbacks from trading costs, leverage restrictions and tax implications.
If you are wanting to sell gold at these price levels then if you own physical gold you can simply sell it to a bullion dealer and cash in on the current all time high prices. However, if you want to short gold and sell some that you do not currently own there are multiple options.
If you have read my blog posts on my Tesla short trade escapades then I recommend you do so because I explained options trading strategies and how they work in relative detail. Shorting an asset or security like gold with options is very good because you can have a defined risk value with the ability to let the price of the asset keep going up infinitely in-between the date of purchase and date of expiry of your options. However, this comes at a cost…
Shorting gold via options is very expensive right now. Volatility costs money and gold is highly volatile right now. If you look at the chart above, you can see that as of Tuesday this week, gold volatility is still more than double it was at the end of last year. This make purchasing put options expensive and this reduces potential profits.
The other option is to short gold futures or spot gold itself. This is perfect acceptable but you must be able to define an upside limit to get out in order to calculate your risk and this is hard when it seems the whole of the finance industry is happy to keep buying the precious metal right now.
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