Sunday, April 21, 2013

A Few Questions for the Goldbugs to Ponder.

Recent developments with severe gold price drop generated, predictably, a lot of controversy, hair pulling, arm wringing and, even more predictably, widespread accusations of manipulation. I want to address those of you who bought into great story of gold going up, up and away, never to look back...  and now searching for answers to many questions this drop puts in front of you. Not that I can provide all the answers but I want to offer you a framework in a form of a few questions you need to ask yourself.

Before we continue however, let's define my audience. If gold is a thing you just like to own whatever the price, stop reading. If gold is a cult for you and you must own it to belong, whatever the price - stop reading. If gold is a form of a protest for you, whatever the price - you are not my audience. We will simply talk past each other since I speak of completely different aspects. So, without judging each other, let's just part our ways, so I can address my audience. Now, if you view gold as a part of your portfolio or a sector for your trading activity, if you do care about the price, want to protect your account and trade for profit, not for abstract social ideas - continue reading. If you read everywhere about how gold was/is/will be manipulated and wonder what to do, continue reading. If you got caught in this price drop and wonder what to do , or you are out of the gold market but are looking to get back in - read on. You are my target audience. With that in mind, let's move on to the questions I want you to ponder.

1. Manipulation (let's not discuss it itself here lest we cloud the real issue, we spoke about it here before) manipulates PRICES. It doesn't manipulate YOU. It may cause price to drop, but your account drop is still YOUR doing. Was it your choice to ignore what charts said, or manipulator's fault? It's not like charts were silent on the drop coming - many warnings were posted by solid chartists, and you, as a student of the market, did look at the charts as you contemplated your course of action, right? You might have noticed how the story said up but the price remained stagnant - remember our discussion about Price-Information Divergence?

2. If manipulation, or intervention (the term I prefer for many reasons) is a fact of life, why doesn't your trading system includes it as one of market forces? Sound trading approach encompasses everything that influences the market. Each force that moves the price is a factor to consider. Tape Reading for ages defined two major classes of such forces as Smart Money and Crowd, advancing the idea of Smart Money footprints being different and readable. If your friendly market manipulator is not such entity representing Smart Money, then who is? What I am trying to say here is, reading the market was always about decoding what Smart Money is doing vs. what Crowd is doing, with idea to take the side of... well, you can finish the sentence yourself. How in this regard is gold different from any other asset that went up and then down in the past? Over last decade and half we went through what, 3 major bubbles? Tech boom, real estate boom, oil boom? Oh, this time it's different? Sure...

Now I want you to get really scared. Not with paralyzing fear that won't do you any good but with healthy fear that is a necessary part of a trader's arsenal; it works as a safety mechanism, keeping you careful and putting smoke detectors and fire extinguishers at each level of your (financial) house. So,

3. Let's recall some details of the oil boom of 2008. It was quite recently, shouldn't be too hard. Please do some simple math. Calculate the percentage of a price drop that oil experienced, from $150 to $35 (rough numbers, we don't need them to be accurate to the cent) before recovering to about $70-80-90. Calculated? Now apply this percentage to the gold top of about $1950 and see what bottom price you come to. I'll wait for you to finish the math, faint and return from your blackout.

... You are back? Good. Now, I am not saying this is what WILL happen. What I am saying is, it's a possibility. If someone tells you it's not, ask yourself:

4. If it could happen with oil, blood of the economy, commodity needed by each and every sector and country, why can't it happen with gold? Oh, I know, you've read that cost of gold production is rising and that will put a floor under the price... I remember reading the same about oil in 2008. Didn't help. Market tends to overshoot on both sides, and while drop to $32  was certainly overdone, it still poises the question:

5. Can you survive such drop should it come to pass? If you are in gold from $300, sold part for solid profit and are holding core position only, you don't have to fear much. If, however, you bought into the story closer to the top...  Oh, I know, "but the governments continue printing useless paper, gold is a hedge..." This IS the story, and it's not confirmed by the charts. Sure, there is a cool chart circulating where the rise of debt corresponds with rise of gold. What this chart doesn't show you is a 2 years-long stall in gold while all kinds of QE were ramped up all over the world. Thus, last question:

6. Is it possible that there is no intrinsic connection between debt and price of gold? That this connection is mostly psychological, exists in investor minds, caused the whole run from 2001 to 2011, and this story has played out?  The idea of gold priced in $30,000 or something like that based on the amount of debt is, in turn, based on the assumption of gold standard return - so are you willing to invest in this assumption?

I know, next question to me is going to be: so, what price your charts indicate? As I said many times before, charts have no predictive value. They have instructive value. At this point gold chart does not instruct a buy. The path of the least resistance is still down. You want to hunt for a reversal, read this first.

Oh, and answering first e-mail I am likely to get: no, I don't hate gold. I trade it in whichever direction chart instructs me. Not to go too far for an example, this is where we went long GLD for an intraday trade.