Speculators wary of gold bubble

The gold price has been particularly erratic of late as evidenced by the movements recorded for today and back over varying time periods and sourced from goldprice.org:

At $1235/oz, investors reasonably want guidance as to what may lie ahead, and analysis of historic pricing and the factors that affect the price of gold suggest that the multi-year gold bull market is in the process of unwinding.

As a general observation, financial bubbles typically deflate more quickly than they inflate, and whilst it is tricky to determine what lies ahead, in seeking to identify periods in history that may be comparable, and provide some guidance as to what we may expect, given that the price of gold in US dollars was fixed until the end of the Bretton Woods system in 1973, there is only one period of recent history against which we can compare the current price trajectory – that of the late 1970s through to 1982.

There was a strong bull run in the late 1970s followed by a material retracement, and if the pattern of price up-move and subsequent down-turn experienced in that period, were to be repeated, there would be a lot more downside to come for the gold price.

In assessing the reasonableness of the matching of the end 1970s and early 1980s with today, it’s interesting that after the initial peak in February 1980 the gold market moved broadly sideways at a high level before investors seemingly threw in the towel en masse some nine months later. The current bull market appears to have ended in a similar fashion, with the price peaking in August 2011, and then apparent capitulation beginning 13 months later in September 2012. Then eight months after the collapse began in late 1980, the price of gold had fallen by 33% and today, eight months after the rot set in the price has fallen by about 22% (measured on a monthly basis, although on a weekly basis it is closer to 30%).

30 years ago, the gold price declined to what turned out to be an interim low, 20 months after the capitulation phase began – and at that point, the price of gold had fallen 59% from where the selling began, and 63% from the absolute high.

It would be wrong to assume that cycles repeat precisely, if only because there are so many factors that intrude on pricing, but for the sake of completeness, if the pattern as experienced in the late 1970s and early 1980s was repeated, then the price of gold would move to the region of $710-$725 per oz by July 2014.

To be clear, that is not a forecast but it is intended to point to the significant downside risks when speculative sentiment shifts and we should be wary of false signals – in the unwind of the 1970s gold bull market there were two rallies of between 11% and 15% of the gold price, and with the benefit of hindsight, both these rallies turned out to be excellent opportunities to sell gold.

In the current episode, we can argue that this has also been true of this April’s bounce of approximately 13%, and is also likely to be true of the current rally, which may turn out to be short-covering. That doesn’t mean that there cannot or will not be an extension of the current bounce, which from a technical perspective could be back up to the previous support area, now turned resistance, around $1,300/22/oz. That sort of level would be 10%-12% up off the most recent low, and could therefore become a deemed entry point for fresh tactical shorts.

It’s to be noted that we have not penned one word on the fundamental value of gold – and for us gold is a speculation and not an investment; but our point is that whereas speculators have made good returns as is the way with bet-taking, that may now be changing.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla