Investment Postcards from Cape Town

I am spending a few days of the Christmas break at a village alongside the coastline of the Cape Town Peninsula. It is quaint, picturesque and simply an ideal location for enjoying quality time with the family. The only drawback is that it does become quite windy on occasion - at best not a highly predictable event. This reminds me of the erratic behavior of gold bullion - you just never know with what action the yellow metal is going to surprise you next, making it infamously difficult to predict short-term movements.

And true to form, just as traders were bargaining on a quiet Christmas period, gold again startled with a $15 jump, taking the price well clear of the $800-level. (The rally commenced more than a day prior to the assassination of former Pakistani Prime Minister Benazir Bhutto.) Interestingly, gold has never in its history recorded a month-end price above $800 and only closed above this level on two days during its 1980 surge, namely: $830 on January 18, 1980, and $850 on January 21, 1980. That, however, represented a blow-off with the price plunging to $737.50 a day later and falling further to $659 by the end of January.

It would seem that gold bulls may very well have reason to toast bullion next week, saying goodbye to 2007 having achieved the $800 month-end milestone. There is, however, quite an important difference between 1980 and the present situation. In 1980 gold was in a parabolic rise, whereas since the low of $250 in 2001 gold has been rising methodically, mapping out consistently higher lows as shown below.

Source: StockCharts.com

The upside breakout from the pennant consolidation pattern is a bullish technical development and looks well supported by the rising momentum (top section of graph) and MACD (bottom section of graph) indicators.  

The gold price has not only strengthened in US dollar terms, but has in fact been appreciating in most currencies - an indication of increased investment demand. The following graph and table (not yet reflecting the post-Christmas rally) clearly illustrate this phenomenon.

Source: Plexus Asset Management (based on data from I-Net)

Source: Plexus Asset Management (based on data from I-Net)

The pressing question is how sustainable bullion’s uptrend is. Although the technical picture indicates a primary bull market, the fundamental situation offers both bullish and bearish arguments.

The arguments in favor of a rising gold price have been well documented and include: the possibility of ongoing pressure on the US dollar, increasing global inflationary expectations, a surging oil price, minimal new mine production, and the fact that central bank sales are capped through the Central Bank Gold Agreement (CBGA II).

The bears, on the other hand, point to: record long speculator positions that have in the past been strongly correlated with gold price corrections, potentially lower fabrication demand from India (as a result of the higher price), and a slowdown in producer de-hedging as the global hedge book diminishes. Additionally, a seasonally weak period is approaching from February to April as illustrated by the graph below.