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Will Gold Wake Up From Its Sleep?

By: Lior Alkalay
Posted: 4/27/2012 2:13:00 PM
Referenced Stocks: GLD

By Lior Alkalay
eToro Senior Analyst

It wasn’t too long ago that investors had seen Gold prices surge all the way towards $1,930, but now it seems the precious metal has been banished to the sidelines. The $2,000 record that every investor was sure was going to be struck “any day now” now seems ever so far away. Investors are tossing out the yellow metal like it was yesterday’s trash, and crowding instead into alternative assets that actually pay, like stocks or bonds. There are very few good arguments in favor of holding Gold. According to gold bears, when growth picks up, the economy tends to keep pace with inflation so it makes more sense to hold stocks or corporate bonds or even energy futures that are linked to growth rather than a metal – precious as it may be – which pays nothing and has already backed off record highs. All this occurs even as equities’ P\E multiplies, and clearly equity levels – especially in Europe and Asia – are still far from their peaks. Indeed, in recent months investors have been selling off their gold holdings in a big way, and the result is gold prices plummeting some $280 an ounce, equivalent to 15% of its value.

With gold now trading near record lows, and investors becoming more optimistic on growth, many argue that the metal has lost its shine, but is this true? Can Gold ever really lose its allure? Or is it a buy-on-dips opportunity that should be used to horde even more?

From years of experience, I know that Gold patterns are not always transparent and its weakness can be rather deceiving. But if we really want to understand whether there is a valid argument for Gold, one must first look to the place where most Gold investors congregate, i.e. GOLD SPDR ETF or GLD. The biggest exchange traded fund of Gold, which physically holds the precious metal and possess a significant portion of its actual volume, can shed a lot of light on where we are right now in the cyclical demand for Gold.

Data Source: Thomson Reuters

Presented above is the GLD (Gold SPDR) price chart (in blue), alongside the average volume in millions of U.S. Dollars (in green). What we can see from the chart is a very interesting pattern; every time GLD volume spikes higher it is closely correlated with a spike in the GLD price, which is effectively the price of Gold. Even more importantly, the bottoming of volumes shows a rather strong indication on the start of a new bullish cycle. And the pattern is very clear; each time volumes hit bottom they move higher and when they spike they spike even higher, consistently pushing the metal up to new record highs. What can explain this pattern? It is rather simple, once you understand Gold’s dynamics. When there is rising interest in Gold, volumes spike and so the price is pushed higher; however, when volumes are too high it usually means that the precious metal is over bought with too many speculative positions, and then the volume bottoms out. What the chart indicates is one of two things; that Gold is either under-owned or that Gold fundamentals are under-estimated.

And what patterns are showing now, you may wonder? As can be seen, volumes are bottoming and are in line with the overall rising volume lows. Insights from Gold SPDR are clear: the yellow metal is bottoming and getting ready for yet another spike higher. As far as the fundamentals are concerned, many of you might recall that I had earlier predicted that a Gold spike could spook central banks and cause them to take a step back. Well, I still stand behind that analysis. Buying Gold would actually make sense now, as it would allow investors to hedge against an overheated market.

Maybe a week ago, before the U.S. growth data disappointed and the U.K. economy slipped into a double dip, the case for Gold might have seemed somewhat shaky but things are a bit different now, because with growth clearly dipping, inflation could out pace it. And so long as there is a forecast of steady global growth, the case for equities is strong, but once the growth outlook is lowered, it’s not too much of a stretch to make a case for high inflation and with it, a valid argument in favor of Gold.

Once a weekly break of $1,700 occurs it will confirm what the insights of the GLD are suggesting, but the big question is will this transmute into a spike above the latest records? It is yet to be seen, but within that range, it is becoming clearer that Gold is gearing up to move into the higher range of $1,800 to $1,900.