In most years gold prices and gold equities have declined during the summer months (summer doldrums). Should we bet against the summer doldrums this year? I don’t think so. I see some near-term deterioration in the gold market through the summer due to the absence of a catalyst on the scale of global financial collapse.
Gold presents a strong seasonality. According to seasonality, gold’s best buying opportunity is in September while the best selling opportunity occurs in May. Remember the famous “sell in May.”
Why does gold exhibit seasonality?
From the supply side, gold should not exhibit seasonality insofar contrary to grown commodities; gold is mined globally at a steady pace. The seasonality of gold results from the demand side, so gold’s seasonality is demand-driven. Three reasons may explain gold’s bearish summer seasonality:
1) No investment demand. The reason gold prices slump in summer is because global investment demand is weak during the summer.
2) No manufacturing demand. The activity is depressed in the physical market for gold in the summer, as global jewelry manufacturers are not very active during the period.
3) Holidays. Summer season means vacation season so traders flee all the markets (including the gold market).
Nevertheless we should keep in mind that seasonality is merely a secondary driver. Sometimes, seasonality can be temporarily offset by 1) Occasional outliers and 2) Sentiment:
1) Occasional outliers
Sometimes occasional outliers may occur and offset seasonality. The summer 2011 is a good example.
During the summer 2011 gold experienced an amazing rally driven by the fear that the United States would default on its debt on August 2, as no agreement on the debt ceiling was reached.
Specifically, summer 2011 started like most other summers, with gold going sideways to lower. Then gold started to rally after reaching a bottom in early July. The debt-ceiling debate in the US Congress pushed gold higher.
Investors must realize that gold is highly correlated with sovereign debt defaults as I explained in my previous article.
Even though an agreement was reached at the last minute, the stock markets plunged and gold prices continued to increase as gold was perceived as an international flight-to-quality.
The risk of a US default was the catalyst on the scale of global financial collapse that pushed gold extremely higher despite gold’s bearish seasonality.
Indeed, it is always crucial to look at the sentiment in the gold market. Extremely bullish or bearish sentiment can lead to strong price reaction despite seasonality. As a result, even though gold’s seasonality looks very bullish, overbought gold is still likely to correct and even though gold’s seasonality looks very bearish, oversold gold is still likely to surge.
A good example just occurred in autumn 2011. Even though gold’s seasonality was bullish then, gold was so overbought that a correction was likely.
It was surprising to see gold overbought in autumn as this period of the year usually presents the best buying opportunity. Even though it was strange to observe that from a technical point of view the evolution of gold suggested a correction, it is important to understand that seasonality can be offset by sentiment.
Will seasonality be offset by occasional outliers and/or sentiment this summer 2013?
Is there a presence of occasional outliers this summer?
The debt limit in the United States will come back into force on May 19. Does it sound like 2011 when the US stood ready to default? In this context, Fitch Ratings published a note in January 2013 warning that another so-called debt ceiling crisis would probably lead to a reduction in the US credit rating. Failure to increase the limit “in a timely manner would prompt a review and likely downgrade of the U.S. sovereign rating.”
Nevertheless, the risk of a US credit downgrade is minor. First, Fitch Ratings’ expectation is that Congress will raise the debt ceiling and that the risk of a US sovereign default remains extremely low.
Second, according to experts at the Bipartisan Policy Center, the debt limit deadline could come anytime between mid-August 2013 and mid-October 2013.
According to their study, the new debt limit will be on May 19 between $16.6 and $16.7 trillion, roughly $250 billion higher than the previous debt limit ($16.394 trillion). Once that time arrives, the US government will implement extraordinary measures which will allow it to continue to honor its obligations for an additional period of time. As a result, BPC estimates that “the X Date will occur between mid-August and mid-October of 2013, with the most likely points in that range being early September or early October.”
In short, it is reasonable to expect that the debt ceiling will not cause a storm in the financial markets and not push gold prices higher through the summer contrary to what happened in 2011.
Here is a table of the different countries in the Eurozone with S&P rating and S&P outlook so we can easily monitor the countries that could be potentially downgraded through the summer.
The S&P outlook is crucial because if the S&P attaches a “negative outlook” to a country rating, it is a warning of another possible downgrade in the medium term (3 months in average). Consequently, if a country’s credit rating is downgraded, it could destabilize it and raise its probability of default that could lead to the aggravation of the sovereign debt crisis.
Source: The Guardian
The economic conditions of “periphery” countries such as Greece, Portugal and Cyprus have improved. So in the medium term they are not at risk as they have stable outlook.
Standard & Poor’s stated in a note published in April 2013 that Cyprus’ credit-rating outlook was raised to stable from negative because it expects the troubled government to agree on the terms of a bailout.
Standard & Poor’s announced in a note published in March 2013 that Portugal’s credit rating outlook was raised to stable from negative as European lenders will probably extend support to the government and make the nation’s fiscal tightening “more sustainable.”
Standard & Poor’s stated in a note published in December 2012 Greece’s credit rating outlook was raised to stable from negative as countries using the euro are determined to keep Greece inside the currency union.
The big risk in Europe this summer: Spain
Among the countries in the Eurozone, the biggest risk is Spain because it is the only country with a credit rating one notch above “junk” status and a negative outlook.
According to an article published in the Telegraph Journal in October 2012, the S&P declared it would downgrade the country’s debt status further if political support for Spain’s structural reforms weakens, if the Eurozone support fails to prevent Spain’s borrowing costs hit unsustainable levels or if debt tops 100% of economic output or debt payments go above 10% of general government revenues.
However, it is unlikely that Spain will be downgraded in the medium term. Debt has not topped 100% of economic output yet. Last data published in April showed that government debt reached 84.2% of output in 2012. Second, Spain’s 10-year government rate fell below 4%, the lowest since November 2010. Eurozone “periphery” government bond markets have rallied strongly since Mario Draghi said last year to do “whatever it takes” to preserve the Eurozone. As a result, it is reasonable to think that Eurozone countries will not have their credit rating downgraded through the summer.
To conclude, the presence of occasional outliers this summer is quite unlikely. The next big outlier to watch that can push gold prices extremely higher is German elections in September. Recent polls suggest that neither CDU/CSU and FDP (black-yellow coalition) nor SPD and Greens (red-green coalition), partners in the 1998-2005 Schröder government, would have the possibility of gaining a majority of seats together in parliament. The possibility of a messy result in September with no clear winner could aggravate the sovereign debt crisis and could be the catalyst that gold needs to begin a strong rally.
Can seasonality be offset by sentiment in the gold market?
Gold took a serious hit in late April with prices falling well below the strong $1500 support to bottom at $1326 on April 15.
The plunge resulted in an extremely oversold condition. The Hulbert Gold Sentiment Index shows that the majority has turned bearish on gold and sentiment dropped to a level even more depressed than at gold’s 2008 low.
As sentiment towards gold could not get any worse, it could only get better. That is why gold started a rally.
Should we deduce that gold is now ready to start a new rally because the sentiment towards gold reached an extreme low?
In my opinion, as the sentiment in the gold market was extremely negative, recent gains in gold are not surprising. The rise in gold prices has allowed to alleviate the short-term extremely oversold condition. In the short term, we could expect an improvement in the gold sentiment.
Nevertheless, gold is not ready to start a new rally and is likely to head lower in the short to medium term because first the plunge on massive volume late April is normally a very bearish development that suggests a longer-term decline. The graph below shows that volume traded was twice as high during the plunge in mid-April compared to the average. Second, the past shows that oversold condition can last for a long period such as in 2012 so it is likely that gold will remain in oversold territory. Lastly, the summer months are near and summer seasonality is also bearish for the precious metals.
To sum up, in the short to medium term, gold prices could continue to increase a little bit longer before falling down sharply again to reach new lows if the price of gold does not break above the former $1500 strong support that is now a strong resistance. In order to see gold start a new rally, we need to wait for an event that will aggravate the sovereign debt crisis. It could be in Europe with German elections on September 22. If Merkel has difficulties to remain in power, the Eurozone could be in danger and gold could start a rally after the summer.