Leaving the Year of GOLD – 2011

As we come to the end of the 2011 roller coaster ride, now is a good time to review strategies and check on the macro perspectives shaping our approach to 2012. One particular change in commodities we have seen recently has been a significant break in technical support in the price for gold accompanied by a fundamental shift in the demand for gold.

In terms of the price for gold the commodity, there has indeed been a significant technical deterioration in recent sessions, and after being bullish on the major trend for gold for some time, we now view the long term outlook as being in no better than a neutral but weakening position. The fact that for the first time in close to 3 years bullion has broken below its 200 day moving average is a clear warning that a potential topping pattern is now starting to form. So, while it’s oversold near term, we would not do buying at this time but instead use rallies in the price for bullion back toward 1615 – 1650 (basis February) to do additional reducing in positions. Thereafter, down the road, a close below 1535 versus February would signal the beginning of a more serious bear market move.

There are also some fundamental changes to the demand for gold.

In the past 10 years, Exchange Traded Funds have entered the markets. Gold ETFs are backed by the physical commodity. With approximately 2,000 tons being used to support gold ETF’s, the demand for the commodity from financial products has grown to multiples of the physical bar and coin commodity. But gold ETF asset growth has been decelerating for months.

In addition, we are beginning to hear major commodity trader financiers pull back from the market, which also would have negative implications for the financial demand for gold among other commodities.

In addition, gold’s behavior relative to other investments has shifted – from negative correlation to equities during some of the scariest economic episodes of recent years, to a positive correlation recently. The inverse correlation has happened in the past with announcements of quantitative easing when equities rallied and demand for protection against inflation was at a premium. Inflation protection is not needed now. Also, Gold has rallied in the past with the rise of sovereign default fears. This role is in part being filled by “haven” currencies such as the U.S. dollar, another factor in making gold move more in line with stock markets.

If the positive correlation to equities continues early next year, recent buyers may lose patience and look elsewhere, to stocks what pay relatively high and reliable dividends given the new correlation, for example.

So as we prepare for the new year, we will continue to monitor the correlation of gold to other assets and the trend in financial demand for gold in particular. In particular, we will watch for the price to climb above gold’s 200 day moving average supported by increasing financial demand for the commodity.

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