Is gold losing its shine?

Gold closed slightly above 1,360$/oz last week, the lowest close in 2011 and in almost two months. At the start of the year, gold traded above 1,420$/oz. This raises the question whether gold has entered a new down-ward trend while most forecasts for gold in this year are bullish.

From the perspective of a technical analyst, the answer is not a clear “yes, the trend has changed”. Based on closing prices, the trend has reversed according to the Dow Theory, as last Friday’s close was the lowest since mid-November and it was below preceding reaction lows. If the analysis is based on the whole trading range of the day, the trend also has clearly changed according to the Dow Theory. However, gold found support at the upward trend line, which connects the lows made in November. Therefore, gold would still be in an upward trend. The highs, which gold made since November, are in close vicinity. The upper Bollinger band line is also moving sideways with only little fluctuations. The lower band line moved higher, but lately indicates that gold is caught in a trading range. In addition, gold found support last Friday at the lower Bollinger band line. Therefore, all in all, we would regard gold being in a correction within a sideways trading range as the most likely scenario.

And a sideways consolidation of gold after the strong increase since August 2010 should not come as a surprise. If a market is overbought, it takes some time to digest the gains. The timing of the recent correction is also not a big surprise. Some accounts are market to market and unrealized gains are treated as a profit. For managers of those accounts, there is little reason to sell gold based on accounting reasons. However, some accounts value gold at book-entry levels. Managers of those accounts have an incentive to realize gains at the start of a new fiscal year to lock in already a profit. Such a behavior has also been observed in other markets in the past. Unless, the expectations of those account managers have not changed, they will repurchase gold again at a lower level, which should provide some support for gold.

Last week, we already pointed out that gold suffered from a firmer US dollar based on some stronger than expected economic figures, which had triggered expectations the Fed might hike interest rates later this year. During the course of the previous week, it was more the debt crisis and the ECB which moved gold. At bond markets, the fear was widespread that the auctions of new debt from Portugal, Spain and Italy would attract insufficient bids from investors. As a result, the euro was weak, but gold rose due to safe haven buying. However, as after Portugal also Spain could sell new bonds without problems, the euro firmed but investors sold gold as they sought more risky assets. Despite the countries of the eurozone periphery could place new bonds, the debt crisis is far from over. Market pundits still point out that these countries are not out of the woods. Therefore, a renewed flight to the safe haven of gold could set in anytime.

However, what is likely to have a stronger impact on gold over the medium-term horizon is the recent ECB press conference. The ECB attributes the rise of the eurozone inflation rate, which came in at 2.2%, above the target rate to higher food and energy prices. The ECB also expects that inflation would remain above 2% over the next few months without expecting that inflation would deviate from the target over the medium-term horizon. Nevertheless, ECB president Trichet sounded more hawkish than the market consensus expected by stating the ECB would not be pre-committed and would be ready to act when needed. Mr. Trichet also referred to 2008, where the ECB hiked interest rates while other central banks already eased monetary policy. This is a clear message to markets that the ECB is likely to lift interest rates ahead of the Fed. This would be supportive for the euro against the US dollar and would probably also push gold prices higher.

One development over the recent weeks presents a short-term risk for gold, but could also be the catalyst for the next rally in gold. Financial investors have reduced their exposure in gold. According to the weekly “Commitment of Traders” report compiled by the CFTC, large speculative accounts have reduced long positions further by 15,972 to 234,333 contracts and have increased the short positions by 8,974 to 56,961 contracts. Thus, the net long position dropped by 24,946 to 177,372 contracts, the lowest net long position since the end of May last year. Also the gold holdings in the biggest ETF, the SPDR Gold Trust, declined further to 1,259.3 tons, again the lowest value since May 2010. Against the backdrop of these huge position liquidations, the price of gold held rather well. However, further position liquidations by large investors could be the straw that breaks the camel’s neck. But in the case that gold could remain in a sideways trading range, financial investors might return as buyers in the gold market and could set the stage for another major push higher. Thus, it is far too early to conclude that gold has lost its shine.