Gold Price Outlook – the Long and Short of it

The Long-term Outlook, Three-Five Years

My outlook for this period is very bullish. Having spent both the peace and productivity dividends of the last few decades, the current direction of government policy – increasingly interventionist – threatens to set in motion the forces of capital flight… into gold. The effect of this on the dollar will be historic. There is no more honest a measurement for this forecast.

However, it is a three-five year outlook. It may start to unwind tomorrow, or perhaps not for two or three years.

Technically, the long-term chart contains no great knowledge. I don’t put much stock in the charts of any price trend spanning more than 10 years. My calls would lag major turning points by about five years. But as far as the long-term chart goes, the gold price is still in a long-term bull market.

The last highest low in the eight-year bull trend lies at around $540, which is just above the final resistance point of the previous bear – the break out point after which the gold price accelerated in 2005…the year that Bernanke was chosen to head up the Fed. Go figure – turns out gold was right about him.

However, the more normal “primary” trend support lies at around $700.

The “primary” trend is the sequence that shows up most prominently in the five-10 year (weekly or monthly) chart.

In the case of gold, it is the trend that began back seven or eight years ago.

In a normal trend, the correction lows stop at previous highs, or resistance levels, which are at the $700 mark here. Note that the bulls bumped up against that level a few times during 2006 and 2007, before ultimately breaking out. That just makes support that much more significant at this level.

However, during a correction to the primary sequence, the normal support points might fail, and it becomes difficult to figure out whether it is still a bull market at all. In other words, it is possible to see gold prices fall to $600, or even $540, even if the general bull market is still on.

Percentagewise, a correction of just such magnitude occurred in 1975. Gold prices fell from around $200 per ounce at the 1974 peak to just above $100 a year later, before soaring to new highs, and to over $600 by 1980. So the long-term technicals tell us almost nothing, except that there is room on the downside whether or not the bull market is still on.

There are two facts, however, that argue against a correction of the same magnitude today.

One is technical, sort of, and the other is fundamental.

From a technical standpoint, it should be noted that the advance in gold prices leading up to 1975 was larger (percentagewise) than the advance from the $260 low in 2001, and occurred over a shorter time frame. I don’t know how much that may be worth, but it’s something to consider.

Fundamentally speaking, moreover, simply comparing the Federal Reserve’s policies today with those of 1973-74, when it was similarly trying to rescue the world economy from a crisis that saw a 40% decline in the Dow, it cannot be denied that the current policy is far more inflationary… more bold… more off the charts, if you will. If the Fed underestimated its contribution to the inflationary events of the ’70s, as Bernanke argued in a speech about inflation last year, what is the 2008 Fed doing?

The Medium-term Outlook, One-Two Years

My outlook for this period is also quite bullish for gold, as the positive short-term effects of the government’s current policies begin to wear off and the negative effects start to set in sometime in this time frame. I know this is counterintuitive to anyone who believes what the government is doing today is beneficial, but that is really the only way it can work. In this period, you will see asset prices recover, along with commodity prices, and maybe even a fleeting boom (bubble) somewhere, like in biotech, or public works – wherever. However, the rising tide won’t come in fast or high enough to keep all the boats rising like in other bull markets, or even in significant bear market advances.

Let me distinguish here between a recovery in the economy and reflation.

I expect significant deterioration in the economic fundamentals in the medium term. However, much of it is priced in, and the effects of monetary debasement will underpin the dollar value of the soundest assets. Indeed, only the soundest equity or real estate assets will provide real protection against the confiscatory policies of governments over this period. These include gold-related assets, and some of the other important commodities, though it isn’t certain whether gold will outperform in this time frame.

It could take a full year for inflation expectations to recover from their current trough.

Moreover, although the Fed has been a leader in the reinflation program in 2008, it had not inflated nearly as much as the other central banks between 2003-2007. This fact created the illusion of a global boom that would sustain even as the U.S. economy recessed. Now it is being liquidated.

That is one of the reasons the commodity liquidation was so excessive, and also why the dollar rallied this summer. I don’t know exactly what to expect from the dollar in the next year or two, but at best, trade should continue to be choppy.

Currency markets won’t offer much opportunity for most people until the dollar’s bear market resumes – sometime after 2009, in my judgment. However, this should not hinder gold’s performance. Moreover, my feeling is that the Fed will pursue a low interest rate policy for longer than other central banks, which will eventually be the catalyst that undermines the dollar and sets it up for the final chapter in its bear market – the one that leads to a brush with hyperinflation.

Technically, the intermediate trend (i.e., the nine-month trend) is still down. The bulls have bounced off normal primary support at $700 nicely, and October tends to herald correction lows, seasonally speaking. Most of my leading indicators, including gold shares, moreover, suggest the low is in.

The technical objective of the seven-month top formed January-July 2008 was also already achieved at $695, plus or minus, suggesting the bear leg is complete. However, until the last lowest high ($940) in the downtrend is cleared, we have to tame our enthusiasm. What’s more, the current rally has stalled at the downtrend line, which intersects the current time horizon at about $890.

If the bulls can’t make it back up to at least the $940 high of September/October before the market falls back through $830, then I would worry the market MIGHT either retest its $690 low, or go lower.

The Short-term Outlook, One-Three Months

My outlook for this period is neutral to bullish, with the possibility of one more test of support in the mid-high $700s if bullish sentiment returns to Wall Street prematurely. Although the policies governments are pursuing are fundamentally and relatively bullish for gold, it is more than possible that they engender a recovery confidence in the short term that may hinder the performance of gold.

Technically, the objective of the October-November ascending triangle (bottom) in the chart below has completed at $875-880.

The last highest low in the short-term sequence is around $830. If the market falls through this level before extending the current rally to the $940 area, as mentioned above, there is the slight risk that there is something wrong with my bullish medium-term (or intermediate) outlook above.

But this risk is not that great considering all the bullish permutations that could still take shape on the chart. Still, the most likely scenario in my mind is for a pullback to somewhere between $750-800, whether or not the current two-month sequence extends to $940 in the next few weeks.

If the pullback starts now before a higher high, I’d put it at the low end of the shaded area in the chart ($740); if it starts higher, say from $940, it could stop a little higher, like $775-800.

But until we get over $900, the $830 handle should be watched, as a break through it before a higher high could trigger the liquidation of the two-month advance and start a correction to at least $775.

Ed Bugos
for Markets and Money

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