Gold – Has The Bear Case Merit?

Pater Tenebrarun

It is astonishing how quickly mainstream opinion has turned against gold, in spite of the fact that it is actually only moving in a broad sideways channel since peaking in late 2011 (in dollar terms, that is. In yen terms, it is making new highs, and the gold chart looks considerably more constructive in most non-dollar currencies). As far as we are aware, at this juncture, a single mainstream bank remains bullish on gold, while all the others have turned solidly bearish.

The most recent example for this was a report on commodities by Goldman Sachs (GS), which recommended that punters “buy the dip in commodities,” with the sole exception of gold. The logic behind this recommendation is that the “economic recovery” is for real, and that therefore, industrial commodities should outperform gold. Gold, meanwhile, has moved sideways against industrial commodities for the past two years.

The problem with this recommendation is that it relies way too much on the “message” ostensibly sent by the U.S. stock market and the release of improving aggregated economic data. It assumes that the stock market “knows something,” a myth which we have hopefully successfully dispelled a while back. It is actually a great example of the problems associated with relying on economic and market statistics rather than logic.


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The Gold-CCI ratio, going sideways for the past two years. This looks like a bullish consolidation, actually.

We want to point readers to this excellent recent commentary by Steven Saville, entitled “Fantasy-Land for Policymakers.” As Saville rightly points out, when the central planners print money, they have absolutely no control over where this money will go. It can, therefore, happen that at times, it goes exactly where they would like it to go and avoids areas where they wouldn’t like it to go.

This is the case at the moment, as stock markets are rising, while commodity prices and the gold price remain subdued. That is, however, not a sign that some glorious master plan is coming together; it is mere coincidence. On the part of market participants, we could call it an example of “faith based investing.” Faith that central planning will somehow “work” just this one time, can be rewarded for considerable stretches of time, but it is ultimately misguided. As Michael Pollaro points out in another highly recommended article, “price inflation” is really the least of Ben Bernanke’s problems. The biggest problem is that he is laying the foundations for yet another major bust.

We have frequently pointed out here that a rough approximation of what happens to the economy’s production structure – the ratio of investment in capital versus consumer goods production – indicates that the economy is becoming increasingly imbalanced. In essence, the current capital structure is one that increasingly ties up more consumer goods than it releases, an inherently unsustainable trend. There must be enough saved consumer goods available to sustain not only pre-boom consumption trends, but also the workers employed in all the new long-run, capital intensive projects that have been started due to appearing profitable on account of artificially low interest rates. Once the ratio of investment in higher order goods production relative to lower order goods production gets so skewed that it extends beyond what Roger Garrison calls the “production possibilities frontier,” an economic bust can no longer be avoided.


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The ratio of business equipment to consumer goods production.

In short, we know that the current “Goldilocks” scenario implied by the stock market’s relentless advance and the improvement in aggregate economic data – which only tell us that there is more “economic activity” than before, but not if said activity is actually liable to produce genuine wealth or will instead rather consume scarce capital – is actually a mirage. No economic upswing brought about by massive monetary pumping can ever be anything else. To be sure, the market economy produces genuine wealth even during a boom, in spite of the ministrations of the planners. It is not necessarily so that society will be poorer after the boom ends than it was before it began. However, the malinvestments that accumulate during the boom will have to be liquidated eventually, there is no way around that. The longer this moment is delayed by even more monetary pumping, the worse the eventual denouement will be.

In short, the bear case for gold actually does not have much merit, especially in the longer term. However, it should be pointed out that the bears may still have a case in the short to medium term. It is inherently unknowable for how long the “Goldilocks mirage” will be maintained. This depends on a great many factors that are inherently unmeasurable and unpredictable. However, as will be seen below, the case for at least a short-term upswing in gold and gold related investments is becoming stronger, even though additional confirmation is still needed.

Gold and Gold Stocks – A Brief Technical Update

Gold’s chart in dollar terms looks ripe for at least a short-term rally. The recent probing of the lower support levels has not yielded a breakdown, so it is to be expected that there will be some short covering that could propel prices for a while.

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Recent volume spikes and a tentative MACD buy signal indicate that a short-term rally may be in the offing. Short-term resistance at the $1620 level needs to be overcome to confirm the trend change.

Moreover, there have been interesting divergences between gold in U.S. dollar terms and in terms of other currencies. An excellent example is gold in terms of the British pound, a currency that similar to the yen, has been quite weak lately. Gold prices in dollar and pound terms have tracked each other very closely, until very recently:

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Gold in terms of pound sterling (candles) and the dollar (green line) – recently prices have diverged considerably, as the pound has weakened. This strikes us as a potentially bullish divergence.

The biggest worry for gold bulls has no doubt been provided by the extremely poor action in gold stocks, both in absolute terms and relative to the gold price. However, the sector is also showing tentative signs of life lately, and for the first time in a long time, the ratio between gold stocks and gold is not only rising, but has put in a higher low.

That said, the technical damage done to this sector has been enormous. There are now numerous levels of overhead resistance that must be overcome, while there is conversely very little technical support visible on the longer-term charts, due to the strong and nearly uninterrupted rise following the 2008 crash low.

Still, in the short term, the sector deserves the benefit of the doubt. In the HUI index, we can see a bullish RSI/price divergence, coupled with a tentative MACD buy signal (mimicking the one in the USD gold price). These are usually strong indications that a short to medium term low has been put in.

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The HUI index: a bullish price/RSI divergence and a tentative MACD buy signal. There are a number of short-term resistance levels that the index will have to overcome. Closes above the 375 and 400 levels would be necessary to confirm a trend change.

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The HUI-gold ratio: rising a bit and it has finally put in a higher low.

On the sentiment front, the recent extremes in bearish sentiment have begun to unwind, as can be seen below:


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Gold, sentimentrader’s public opinion chart. After reaching a one decade low, sentiment is improving rather notably.

The chart above shows an amalgamation of various prominent sentiment surveys. As can be seen, these surveys are quite volatile, but the important point is that an extreme low was recorded and that a change in opinion is now underway. If we see this confirmed later this week by large traders unwinding some of their gross short positions in COMEX futures, we would receive the necessary confirmation that a short-term trend change is underway.


In the very short term, technical signals have turned a bit more positive and are indicating that a trend change may finally be occurring. However, there are a number of obvious resistance levels that still need to be bested to actually confirm the trend change. So it is too early to sound the “all clear,” but there is enough evidence of a short-term low to at least make it worth considering the possibility.

In the longer term, the main question of whether gold is or isn’t a “buy” revolves around the fundamental data. In times of economic uncertainty and economic contraction, people tend to increase their cash balances, and a part of this demand for money is usually expressed in rising demand for gold. The main reason for gold’s recent weakness is an rise in economic confidence, but this seems to be misguided.

What is not known at this point is for how long this increase in economic confidence will be maintained. The longer it is maintained, the more likely it becomes that the gold price will undergo a bigger correction. However, should the current happy state of affairs be replaced by a more realistic assessment of the likely future outcome of the relentless monetary pumping courtesy of the central banks, gold demand is likely to be boosted considerably.

It cannot yet be ruled out apodictically that the bearish case currently favored by most mainstream analysts has merit in the short to medium term. However, it can be firmly ruled out that it has merit in the long term. Regardless of near-term price gyrations, the gold price is highly likely to eventually exceed its 2011 highs.

Charts by: sentimentrader, StockCharts, St. Louis Federal Reserve Research


About abwehra group

The Art&Science of Trading Gold
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