Gold: is this drop a normal seasonal correction? Or something worse?

Last month, I gave three reasons why I thought we could expect to see a pullback in precious metals prices in the near future.

One, because there was a lot of resistance at the $1,800 an ounce mark for gold (and around $35 an ounce for silver).

Two, because there was too much bullish sentiment, particularly for silver.

And three, simply because in early October for some reason you almost always see some kind of shake-out in the precious metals.

“It will be like some short, sharp punch in the ribs,” I said. “Enough to rattle everybody’s nerves and cause a bit of pain”.

Well, I don’t know about you, but my nerves were rattled on Monday. Silver was pole-axed. The mining stocks looked little better.

So is this just the shake-out I expected? Or is it the start of something worse?

Gold could drop through $1,700 in the short term

Looking first at gold, what we’re seeing now reminds me of 2006-2007. Take a look at the chart below.

Gold price 2006-2007

(Click on the chart for  a larger version)

In the spring of 2006, gold stormed to $730 an ounce – doesn’t that seem cheap now? It then had a horrible correction all the way back to $560.

It spent the next year or so, after re-testing that $560 level, unable to get through $680-$700 (where I have drawn the pink band on the chart). It eventually made it through after several tries, then went on to storm to new highs.

But I remember there being much frustration and doubt as gold meandered between $640 and $700 in the first half of 2007.

We’re in just such a sideways period now.

The September 2011 high of $1,920 is like the old $730 number. The area between $1,780 and $1,800 is like that seemingly insuperable $680-$700 area. And $1,520 is like $560, the area of ultimate support.

Looking at the chart immediately below, which shows gold over the last 20 months, you can see how similar the pattern is. I’ve reprinted the earlier chart below it, so you can compare them. 

Gold price over the last 20 months

(Click on the chart for  a larger version)

Gold price 2006-2007

(Click on the chart for  a larger version)

I’m going to stock my neck out and say that the $1,700 mark (we are currently at $1,740) isn’t going to hold.

But I see a lot of support in the mid- to high-$1,600s. Both the 252-day moving average (green line) and 144-day moving average (red line) – which have good track records as indicators – as well as the rising blue trend line I have drawn, should all convene at around those levels and provide decent support.

If that thesis plays out, then silver should find support around $30. But silver being silver, anything is possible, and it really wouldn’t surprise me if it paid $26 yet another visit.

If so, I would expect $26 to hold – unless the world is gripped by yet another panic, of which there are many potential causes lurking.

But – who knows? – the correction may have ended on Monday

The long run is looking good for precious metals

In any case, looking further forward I am feeling rather positive. Talking gold at the weekend with some buddies, the subject of how gold and gold shares perform during post-US-election years came up.

Given that our friends across the pond are deep into their electoral process – or silly season as perhaps it should be called – I had a look some charts and did some back-testing.

The good news is that gold has a habit of doing rather well following US election years.

Below, we see gold since 1970 with red arrows marking each of the 10 post-election years during that period – 1973, 1977, 1981, 1985, 1989, 1993, 1997, 2001, 2005 and 2009.

Gold price since 1970 US elections marked

(Click on the chart for  a larger version)

Gold rose in all but three of them – 1981, 1989 and 1997. Given that those 40 years include 20 years of bear market, that’s a pretty impressive statistic.

I only have charts for the XAU (gold stocks index) going back to 1984. But the gold stocks in this period did even better than gold in post-election years, as you can see below. Gold stocks fell in just one (1997) of the past seven post-election years.

In 1989 when gold was pretty much flat on the year – though with hefty declines in the middle – the XAU ended the year over 50% higher.

XAU (gold stocks index) going back to 1984

(Click on the chart for  a larger version)

So, while the period between now and the election might be decidedly rocky, it all looks very good for 2013. I’m confident both gold and gold shares will have long since broken out to new highs 15 months from now.

For more on which gold mining shares you should consider adding to your portfolio, check out my colleague Simon Popple’s newsletter, Metals and Miners.

Finally, a heads up on African Queen Mines (TSX-V:AQ), which I mentioned in a Money Morning a few weeks back. African Barrick has just announced that it is buying the ground next to African Queen’s Ugunja project in Kenya, via its purchase of Aviva Mining Kenya. That could mean absolutely nothing, but it could also mean it thinks there’s something there, which would be a promising development (full disclosure: I hold shares in African Queen).

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Metals & Miners is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Customer Services: 0207 633 3600.

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22 Responses

  1. 17/10/2012, cooldude wrote

    Dominic you are too caught up in the day to day price of precious metals. Over the last twelve years gold and silver have appreciated by 15-20% on average against every single unbacked paper currency on this planet including the so called ‘strong ones” such as the Swiss Franc. This trend has started to increase since 2008 when the debasement of currencies became official central bank policy. This trend will continue and accelerate as we head into a full scale currency crisis. Technical indicators are at best useless and can be dangerous in stopping people from protecting themselves from this debasement.

  2. 17/10/2012, Bob wrote

    It takes a brave man to dare question whether gold and silver will stop going up – so well done.

    I think silver is going to head back down to 26 in the coming weeks. Long-term I think it will shoot up above 40 but, in the short term, I can see it going down.

    Crisis? What crisis? Oh, that big one on the horizon!

  3. 17/10/2012, lumino wrote

    You have a *non-inflation adjusted* graph of the gold price over the last 40 odd years, where it’s gone from about $50 to about $1800, and then you’re seriously claiming that because 7/10 post election years have seen a gold price rise, there’s a causal link? I wouldn’t bet my money on it!

  4. 17/10/2012, ricardo wrote

    Dominic, cooldude #1 has a point. You’re too caught up in your charts. It’s chartism gone crazy. As he says we all know which way gold is going to go relative to paper money, and bricks & mortar, probably. (Governments are likely to allow builders to print houses just to keep people employed). So ditch the charts and just sit back and enjoy the ride.

  5. 17/10/2012, Neil wrote

    Gold back at mid-1,600′s? Great, another buying opportunity coming up!

  6. 17/10/2012, Elvis Presley wrote

    If Spain calls for help and the ECB starts printing to buy lots of useless Spanish bonds, then I would expect the POG to go up, not down.

  7. 17/10/2012, tuesday wrote

    I’m not to keen on this “feeling rather positive” and “sticking my next out” stuff – haven’t you stuck it out a few times before? What happened to the recommendations in that gold report you were charging for last year?!

    I do admire your recently acquired but honest uncertainty – that seems the only rational attitude to the gold price. But it is wrong to refer to your latest opinion as a ‘thesis’ – it would need a lot more behind it to deserve that description. You can find charts to bolster almost any position. The bulls rationale until recently was the ‘safe haven / hedge’ argument – but gold has been performing pretty much in parallel with the other markets. The new rationale is the paper money argument – but it is meaningless – QE and inflation may drive the gold price to new heights – but new heights of what? Devalued paper money!

  8. 17/10/2012, Boris MacDonut wrote

    Smoke and mirrors. Gold could just as easily fall to half it’s current value. As Oil so definitely should.

  9. 17/10/2012, nick wrote

    So that 40 year chart is meant to make me confident that long term the gold price is going to continue to rise?

    Google image search “price bubble”. All the results look a lot like that chart.

  10. 17/10/2012, Boris MacDonut wrote

    Didn’t we see a chart like that for House prices about 5 years ago?
    Reminds me of the old story of the Turkey who got fed and watered every day for 364 days until Xmas came. He had what we call unrealistic expectations. Optimism bias.

  11. 17/10/2012, Gordon Freeman wrote

    Dominic, you MUST include what’s happening in India in your analysis! The government there is starting to seriously consider clamping down on gold as it is ruining there current account deficit. Plus the gold price in rupees is at all time highs (it has NOT corrected down like in USD/GBP). If they hike the taxes again, and the jewellers go on strike again, that’s a huge source of demand gone (is that why you are cautious/bearish?).

    Plus of course the neverending manipulation by the commercials (checked the COT report lately?). And despite the latest QE3, how come the Fed balance sheet is apparently SHRINKING? It’s all so confusing. I think after the election, markets could actually fall. Popcorn time…

  12. 17/10/2012, Gordon Freeman wrote

    Oh yes, and the small matter of $1920 being ever so slightly higher than $730…if we DO get to $2000, expect margin hikes galore and 10 years worth of supply dumped on the comex in 10 nanoseconds.

  13. 17/10/2012, Phil wrote

    I would expect the correction to end shortly. FOMC meeting is scheduled for next week. Despite improving data from the US it seems unlikely that QE would suddenly be halted. I would expect traders to start initiating new long positions.

  14. 17/10/2012, Nick Fury wrote

    I find myself analysing the Gold graphs myself, almost believing I can see where the price is going to go, but these charts can only be made to make sense retrospectively; we will never know what will truly happen, we can hope but we cannot extrapolate these charts…. ever, they follow no mathematical rule what-so-ever, so don’t bother trying unless you enjoy it or it helps you stop worrying so much. The best you can do is look at the macro events of the world to see what originally caused gold to boom in the first place and see if they are still present…….I think they are and as the gold price escalates then this in itself affects price. Many governments are buying gold as a hedge and which governments have the guts to sell off their reserves?

  15. 17/10/2012, Francisco23 wrote

    With money printing continuing to infinity that is the only pertinent fact to buying the metals.

    The other *potential* relevant fact would be should a government deny the private ownership of gold & silver.

    Charts & trends are irrelevant for the short/medium/long term.

    Recurring dollar cost averaging with monthly purchases of the good metals the only tactic. Buy and hold until the mania starts, and then transfer into other undervalued asset classes at the time…assuming civilisation, law and order is still in place.

  16. 18/10/2012, Kenmei wrote

    As well as a currency hedge, many have bought gold as a means of parking their money and preserving capital pending the availability of better investment opportunities. There are some who think the US is recovering quickly, so a fall in the gold price may not turn out to be temporary.

  17. 18/10/2012, Ian wrote

    Gold bulls always seem to be able to explain away drops, and tell you why you should bet your shirt on Gold, it only takes a few well respected investors to cast doubt on gold and the price plummets and the small investors are left holding the worthless golden baby

  18. 18/10/2012, Ed wrote

    Everyone that holds gold expects to sell it at some point when they percieve it wont go any higher, or they fear it might fall off a cliff like it did in 1980. Does anyone really believe that gold is going to rise to infinity, no they dont, but they expect it to rise more and then they will be clever enough to sell it in time before everyone else does. It is true that currencies are devaluing but gold in 2000 was worth about $250 an ounce now it is circa $1700 which is a 700% appreciation and anyone who bought back then and held on until now has done incredibly well. However even though the dollar has devalued it has not devalued by this amount in other words a year 2000 US dollar is not worth seven times more than a 2012 US dollar, therefore it shows that gold is not being driven up simply by currency devaluation but also by emotion and speculation

  19. 18/10/2012, Bill wrote

    Over the last 12 months the price of gold in USD has traced out a clear cup and handle formation. The bottom of the handle now taking shape on the right hand side should reach one third of the depth of the cup taking it to around $1700 . I expect it will start to rise again after that. Technical analysis aside, financial instability prevails worldwide, money printing continues worldwide so the fundamental reasons for holding on to gold remain.

  20. 19/10/2012, Daikoku Research wrote

    Interesting point about post US election rises in gold prices. All this year the discussion here has been about the fact that immediately after the acceptance speech on the Whitehouse lawn an aide will step forward to announce the economic situation is much worse than they thought during the campaign. This will happen whichever candidate is elected.

    The point being that the aspiring “leader” of the “free world” (no more expensive word than that word free!) during campaigning for power does not tell the truth. Truth in any election is an obstacle to power but in the US the art of the campaign platform is defamation of character, absurdly spurious claims and outright lies about the economy.

    This is why gold rises after a president is elected and this is why once he has his feet beneath the oval office desk in November we believe all hell is likely to be set loose.

  21. 20/10/2012, Turbo wrote

    @tuesday
    “The new rationale is the paper money argument – but it is meaningless – QE and inflation may drive the gold price to new heights – but new heights of what? Devalued paper money!”

    That’s the most near-sighted argument I’ve ever heard. Gold gives you the highest chance of preserving purchasing-power parity for the future, certainly far better than holding rapidly devaluing cash, or going all-in on stocks in a deleveraging world where growth is getting harder to come by. In that world, parity is a good enough target for a healthy proportion of an investment portfolio, particularly when there is a fair chance of a fear-driven mania taking gold far, far higher than parity, at least for a time during the next few years.

  22. 22/10/2012, Beta adjusted wrote

    Hi Dominic,

    this may be of interest to you (and more technical readers) on gold seasonality.

    http://systematicinvestor.wordpress.com/2012/09/29/weekend-reading-gold-in-october/

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