How far will gold fall?

Don’t panic, Mr Mainwaring, don’t panic.

Yes, gold’s been hammered. Yes, silver’s been hammered even harder. Yes, it’s ugly out there. But it’s all perfectly normal.

It’s happened before. In fact, it usually happens once or twice a year. It always seems to happen when the Chicago Mercantile Exchange changes its margin requirements. And it’ll happen again.

And if you’re one of those people who wished they’d bought gold but didn’t because the price had gone up too much, now’s your chance.

A nasty fall for gold

Let me start with the ten-year, log chart of gold. I have drawn some parallel trend lines on either side. As you can see, gold went to its upper trend line, then bounced off it, just as it did in May 2006 and February 2008, the previous occasions when gold got too far ahead of itself.

Spot gold price in the last ten years

Based on this chart, the gold price could fall to $1,200 an ounce and there would still be an argument that the bull market is intact. Unless this exceeds the ugliness of 2008, I don’t think it’ll do that.

So how far have we fallen? The high earlier in the month was $1,920 and on Monday morning we touched $1,530. Almost $400. That’s quite a wallop.

But at the beginning of July gold was at $1,480. We’re higher than we were at the beginning of July.

I’ve always recommended buying gold on pullbacks. When gold pulls back to its 52-week moving average (its average price over the last year), buy then. But, although it would regularly do so between 2001 and 2008, since 2009 gold hasn’t done that. The furthest it’s fallen is to its 144-day moving average and that, as I’ve identified before, has been proving an excellent entry point.

On the following chart, the red line shows the 144-day moving average. We actually went through for a couple of hours on Monday, though outside of US trading.

 Gold's 144-day moving average

It wouldn’t surprise me to see the 144-day moving average fail in the coming months. I’m not saying it will. With all the goings-on in Europe, we’re in anything-can-happen territory. But the evidence of the last three years says it won’t.

The one-year moving average sits at just below $1,500, so that’s another possible target.

Gold and silver have been hit by margin hikes

Over the summer, gold had actually decoupled from stock markets and was behaving like the safe haven it is purported to be. Every time stock markets sold off, money would go into gold.

But then the Chicago Mercantile Exchange (CME) – the world’s largest commodity exchange – upped the amount of margin it required to buy a gold future (in other words, you had to put more money down to invest). There have been three rises since July and in total margins have risen by $5,400 – nearly 90%.

Something similar happened with silver when it went ballistic in the spring. The CME raised margin requirements four times in a fortnight, amounting to an 84% hike.

It’s no wonder both sold off.

It’s easy to get suspicious when this happens, particularly as both times it has stopped the market in its tracks. But the CME does have a remit to calm markets where there is excess speculation. If it ups the amount of margin required, those with too much leverage will have to close their positions.

In the short term it may look ugly, but longer-term I feel it is good news. The weak hands have been well and truly shaken out.

Another factor that will have driven prices down is losses elsewhere. Whether it’s home traders or large funds, people will want to lock in some profit where they have it. Gold and silver are where they will have had it, so that’s where the selling will have come in.

I know from experience this is what happens. The psychology is that you’d rather take a profit than a loss. And it’s a relief to take a profit in a falling market.

The biggest beneficiary of all this has been the dollar, just as it was in 2008. For all the touted ‘safety of gold’, it’s still the dollar people rush to in a panic, largely, I suspect, because they must settle their debt in dollars. There were signs this was changing in the summer, but these have disappeared. One day it will be gold, not the dollar, that people rush to. And the looser US monetary policy gets, the sooner that day will come.

The gold bull market is not over

The fundamentals for gold haven’t changed. I don’t need to remind you of them. I imagine the next few months will see whipsawing and consolidation rather than new highs. Indeed we have already seen quite a bounce off Monday’s lows.

In the event of a 2008-style meltdown – which is looking increasingly likely – gold will sell off. The baby will get thrown out with the bathwater. It usually does. But it was the last liquid asset class to capitulate in this carnage. And just as then, I expect, should such a scenario occur, that it will be the first to rise out of it all.

The only thing I can see that will kill my conviction that this bull market is not over is the kind of deflationary crash the likes of Robert Prechter have been predicting, where the Dow goes back to 1,000 points or something stupid. But I don’t think such a scenario is possible. Currencies will collapse first – in which case you would do well to own gold.

We have seen how policy-makers, whether British, American or European, will do everything they can rather than face the music and take the pain. They will be leant on to print, to bail out and to inflate – and print they eventually will. Heck, it appears our lot at the Bank of England are planning to re-start in November.

I took my kids to Thorpe Park a couple of weeks ago. I hated it. My kids loved it. But we’re all already reminiscing about what fun it was. Do the same with gold. Ignore the noise, hold your gold, buy the dips – and in a few year’s time you’ll look back on September 2011 with same fondness you look back at the time you screamed for your life on some crazy thrill ride.

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