Gold will soar in the long-term – but right now, traders should be careful

Gold is hitting all-time highs as paper currencies slide. And in the long run, its price is only going higher. But right now, investors need to tread carefully. Dominic Frisby explains why.

People keep asking me what is gold going to do in all this market turmoil?

I reply, frustratingly it could go either way. I know that's the most annoying of answers, but, really, it could.

There are so many opposing forces at work. So I'd like to consider some of them today

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In the credit crisis of 2008, gold went down with everything else. Gold stocks were hammered as the world deleveraged. But gold and gold stocks were also among the first to rise from the ashes. They made their low in November 2008, while the major Western stock indices carried on declining until March 2009.

Gold was not the safe haven it was touted to be. However, this only reflects what was happening in the paper markets of stocks, futures and exchange-traded funds (ETFs).

In the 'real world', bullion dealers reported unprecedented activity. Such was global demand, that there was a Krugerrand supply crunch in South Africa; the US Mint was unable to supply gold and silver coins; and Tony Baird of Baird & Co, one of the UK's main dealers, confessed to me that he could have had ten times the number of people working for him and still not have had enough staff.

Recommended readingA beginner's guide to investing in gold

And something similar is happening again today.

Germans are buying up gold fast

The FT ran a story on Saturday, headlined: 'Germans lead gold rush frenzy'. It seems Germans are panicked by the inflationary implications of last week's €750bn eurozone bail-out. They have been buying up gold coins and small bars at a faster rate than during the Lehman bankruptcy of autumn 2008. Krugerrands are now commanding a premium of about 8% above the spot price of their gold content.

"We have some extraordinary sales to German customers," says Deborah Thomson, treasurer at the Rand refinery in South Africa. "The refinery," writes Jack Farchy in the FT, "which usually sells 2,000 coins to each customer at a time, says that last week it received an order from one German bank for 30,000 coins. Another bank requested 15,000 coins".

We seem to be threatened with another bout of deleveraging. But this time, unlike in 2008, gold has remained strong in the futures markets. In fact, it is sitting at a vital inflection point. Against the euro and the pound, both of which have been exceptionally weak, gold has gone near parabolic and has long since broken out to all-time highs.

Here we see gold against the pound. It costs nearly £850 an ounce it was just £570 last summer.


And here is gold versus the collapsing euro:


Against the US dollar, however, it is trading at or barely above the all-highs of December 2009 at $1,224 an ounce.


The futures markets are where the price of gold is, largely, determined.

If I was a futures trader and I'm not I would be long gold (betting on the price to rise) in the belief that it could easily go parabolic from here, as has happened in euros and pounds when it broke out.

But, assuming that I have enjoyed a nice run, I wouldn't want to give too much profit back, so I would also have my stops very tight, perhaps at just below $1,220 (near the old high). If not there, I might have them just a little lower, a little beneath the $1,200 mark.

Other traders might not think like me, but there is the danger, in my opinion, that just a small sell-off here could easily trigger a load of stops and drive the price down.


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Why would gold sell off?

But why would gold sell off, given the circumstances? Well, for several reasons. First, sentiment as demonstrated by the Germans is wildly bullish. It is hard to find a gold bear out there. That is often a bearish sign.

Second, gold's move has not been confirmed by silver. Silver, trading at $19 an ounce, is still $31 off its all-time high of 1980, and $3 or 15% off its more recent high of $22 set in spring 2008. I know silver has, for various reasons, a tendency to be rather, shall we say, errant, but like me at school, it should be doing better.

Third, gold's move has not been confirmed by the gold stocks. These are still trading below their highs of March 2008 and December 2009. Perhaps that makes them a buy here, but purists like to see gold stocks leading gold.

Fourth, open interest on the futures exchange is extremely high, with the commercial traders short a worrying 282,644 contracts. These are often levels concomitant with a top.

Now, I am not calling a top here by any manner of means. I remain wildly bullish about gold in the long-term and think we are eventually going to go back to some kind of botched gold standard as the only solution to this ballooning monetary crisis that just won't go away.

And in the event of 'another bout of 2008', I don't think gold will be hit so hard. What was a credit crunch largely in the private sector is now morphing into a full-blown sovereign currency crisis. That should be bullish for gold.

But as I noted above, there are some grounds for 'short-term concern', and it doesn't do any harm to be aware of them.

This small cap remains an exciting play

Finally, a number of you have written in and asked me about one of my tips, Sacre Coeur Minerals (CA:SCM), a small cap operating in Guyana. It has some extremely exciting hard rock assets which they are drilling, as well as some alluvial gold test production which should, once they get operations right, hopefully become commercial production.

The stock has slid in recent months, partly because of the slide in markets generally, but also, in my opinion, because of lack of dramatic newsflow. However, I spoke with chairman Irwin Olian last week and he remains extremely bullish about the company as you'd expect him to be. The geologists are excited about the hard rock we should see some drill results in the next few weeks and the alluvial test mining is progressing well, with the new equipment to optimise operations now on site.

For my money, Sacre Coeur remains an undervalued play in an exciting sector. If you're interested, you'll need a broker who deals in Canadian stocks. One more thing, these microcaps will spike if everyone rushes to buy at once, so offer a price and don't chase it up.

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