A Message For Those Attempting To Pick A Bottom In Gold
July was an ugly month for the value of gold. The yellow metal opened on July 1, 2015, at $1174.60 per ounce based on the now active month December COMEX futures contract. On Friday, July 31, the price stood at around $1095. Gold lost almost $80 or 6.7% during July alone. It was a bad month for commodity prices in general, oil had its worst month since October 2008 falling $12.22 per barrel or over 20%. Copper shed over 26 cents per pound or more than 10% of its value during July falling to the lowest level in six years.
While gold's loss pales in comparison to the decrease in value in many other commodity markets in July, the writing may be on the wall that weakness in the gold market is only the first leg lower in a major revaluation for the yellow metal. Gold's move in July may actually be more significant than the price drop itself indicates. The danger of trying to pick a bottom in gold has risen because of the tenuous technical condition of the yellow metal.
Key support brokenThe significance of action in the gold market in the month that just ended is that it broke below key long-term technical support.  (click to enlarge)
The monthly gold chart illustrates that gold fell below key support at $1130.40 per ounce, which was the November 2014 lows, during the month of July. Gold is now trading at the lowest level since February 2010 - a fresh five-year low. As the price of gold dropped, many holders of the yellow metal threw in the towel with respect to the precious metal. Volume was heavy with over 4.5 million contracts traded during July. While there are cogent arguments for holding gold these days that center around low global interest rates and easy money policies that will eventually lead to inflationary pressures, one cannot ignore the bearish price action in gold. Nor can one ignore the fact that gold is still expensive at its current price, particularly when compared to the price of other precious metals.
Divergences continue to point lowerAt the end of July, gold remains expensive relative to other precious metals despite the recent move lower. Platinum closed July at a $110 discount to gold. This is not the norm for platinum, which is a rarer metal and has a higher cost of production.
(click to enlarge) 
As the monthly chart of the platinum-gold spread illustrates, the range of this relationship over the past thirty years is lows of a discount of $200 and highs of a premium of platinum over gold of over $1200. Clearly, the current discount of $110 is historically a low level and either gold is too expensive or platinum is too cheap on a historical basis. A reversion to the historical mean in the platinum-gold spread implies a gold price of $783.50 considering that platinum closed July at the $983.50 level.
The close in the silver-gold ratio at the end of July yields a similar conclusion. The average level of the number of ounces of silver value contained in each ounce of gold value over the past forty years is around 55:1.
(click to enlarge) 
The monthly chart of the silver-gold ratio indicates that the long-term range in the ratio is from lows of around 15.5:1 to highs of 99:1. At over 74:1 either silver is currently too cheap or gold is too expensive on a historical basis. A reversion to the historical mean in the silver-gold ratio implies a gold price of $811.80 considering that silver closed July at the $14.76 level.
Both the platinum-gold spread and the silver-gold ratio tell two things. First, and most importantly either silver and platinum are cheap today or gold is too expensive. Given the action in all commodity markets since 2011, it is logical to conclude that gold at its current price is too expensive. Second, these spreads tend to move to these levels of divergence (gold's current discount to platinum and a high level in the silver-gold ratio) during long-term bear markets in precious metals. Either case validates the bear market in these metals and point to the fact that gold is far from a bottom at current prices.
Lower lows and lower highsThe best representation of the bear market in gold is the fact that the yellow metal has been making lower highs and lower lows since its peak in 2011 at just over $1920 per ounce. There has been very little love from the gold market for the bulls over the past four years. The recent appreciation in the U.S. dollar, which has an inverse correlation with all commodity prices including gold, is not positive for the price of gold. Additionally, the next move in U.S. interest rates is higher, when the cost of carry increases for gold it is likely to push the price of the metal lower. Only the inflation component of interest rates will provide support for the price of the yellow metal. Therefore, gold has a lot going against it these days. While gold is expensive relative to the price of other precious metals these days, it remains well above price levels seen in years past.
Lots of downside roomGold traded down to lows of $681 per ounce in 2008 in the wake of the global financial crisis, prior to 2008, gold never traded above $875 per ounce and the price in January 2000 opened at $283 per ounce. Therefore, the July closing price of $1095 is not cheap. Gold appears to have a lot of downside risk from the current price level. The break of long-term support that occurred in July could be a watershed event for the gold market in the months to come.
While it is possible that gold can move higher on short covering as hedge funds have gone short on the yellow metal, that rally is likely to be capped at the $1130 level now. That level, which was key-support, is now an important key-resistance level for gold. Considering the upside potential for gold is $35 and the downside could be as much as $300 lower, risk-reward does not favor long positions in gold at this time. It is hard to envision a case for a big rally in gold given the current level of the dollar, rising U.S. interest rates and a bear market in almost all commodity prices.
An eventual bottom - but not yetAll evidence now points to continued weakness in the price of gold. We could be entering a period where today's lows are tomorrow's highs. Gold will eventually find a bottom but it is my contention that the lows for gold will be much lower than current prices. Eventually, the cost of years of cheap money and lower interest rates will catch up with markets and inflation will rear its ugly head. That will be the time for gold to reassert itself once again as the ultimate currency and store of value.
As a bonus, I have prepared a video on my website Commodix that provides a more in-depth and detailed analysis of the gold market to illustrate the real value implications and opportunities provided by this bear market that recently moved into a new zone with the break of key support in July.
For the time being, I think of what a colleague in London once told me about trying to pick a bottom in a falling market. He said, "Andy, when you try to pick bottoms, all you usually wind up with is a dirty finger." My message and warning for those out there who are trying to pick a bottom in gold is wash your hands and stand on the sidelines. You will get a chance to buy gold at bargain basement prices in the future - save your bullets and keep your hands clean. |
