A gold inflection point?
Gold came under further pressure after the G20 gathering last week, as world leaders decided to sell 400 tonnes of the International Monetary Funds (IMF) gold reserves to raise money for aid to smaller economies.
As suggested last week the markets have experienced some profit taking over recent days.
As can be seen from the above chart of the FTSE 100 the index has fallen around 5% from the highs seen after the G20 meeting last week.
Poor economic data from the Eurozone and nervousness about the forthcoming earnings season in the US has caused a halt to the recent rally. However, the nature of the selling appears to be different to what it was two months ago. The recent decline suggests that investors are locking in profits after what has been a good run for equities, as opposed to the panic selling experienced previously. This change in behavior may be due to the threat of banking collapse having diminished in light of the considerable assistance played by the various central banks.
Technical analysis of the above chart shows that there is a clear upward trend that has been in place since the low of 3460 seen on the 9th March. The index has declined to the lower band of this upward channel formation and could continue to move higher.
However, after recently breaking through the technical resistance points offered from the 50-day exponential moving average (EMA) and the previous key support of 4000, the FTSE has failed to hold onto these levels. A prolonged period below these could cause them to provide further headwind to the index.
In summary, I believe the profit taking we have experienced thus far has been as expected and healthy for the longer-term recovery in equities, with further resistance anticipated around 4300. However, a breakout below the recent trend line would negate this view and suggest that a move down to the next support level of 3770 is likely in the short term.
The recent improvement in equity markets and increase in risk appetite has coincided with a fall in the price of gold, which has prompted speculation that the bull run for the metal may be coming to an end.
As can be seen from the above one year chart of gold the price per ounce traded near the $1000 mark in February 2009 before heading lower.
Gold bears have started to emerge, with investors commenting that the over inflated bubble has burst and that further gains are now limited after the turnaround in equity markets, as investors have switched into higher risk assets.
Gold came under further pressure after the G20 gathering last week, as world leaders decided to sell 400 tonnes of the International Monetary Funds (IMF) gold reserves to raise money for aid to smaller economies. This will increase the quantity of gold available in the market and may contain the price in the near term.
However, many other analysts remain bullish on gold. Several central banks have employed quantitative easing as a method to revive the economy and history shows us that increasing the money supply tends to lead to an increase in inflation. Gold is regarded as a hedge against inflation and should therefore remain a part of investor’s portfolios.
Furthermore, equities have performed extremely well of late, with the DOW having it’s best four week period since 1933. Many fear this is just another bear market rally and that we could go considerably lower before turning the corner. If this is the case, it could cause a rotation of funds back into risk averse assets, which may send gold higher again.
Technical analysis of the above chart shows that once again gold struggled to break through $1,000 an ounce, which coincides with the previous high last seen in July 2007. The clear upward trend that has been in place since November last year has been broken and a new down trend has emerged.
Gold prices recovered slightly after hitting an intraday low of $865, which coincides with the support level that was expected from the lower band of the fresh downward channel and the 200-day EMA. A rally off these key support levels could initiate a move back up to the upper band of the channel, which may be capped at around $920. Although, a break higher from there, could prompt a move back up to $960 and would suggest that the fall from $1000 has been completed, thus bringing a re-test of this level. However, a failure to break $920 would indicate that the fall from $1000 is still in progress, with further support seen at $842.8 and $801.5.
If $865 continues to hold and for those investors that remain bullish on gold, I believe that one of the best methods for taking advantage of an upward movement is currently to invest through the gold miners. Lower input prices for mining companies at a time of relative strength in the price of gold will benefit gold miners, as their costs are decreasing while their revenue remains healthy. Also, due to the poor performance of equities, gold companies are trading at a significant discount relative to the price of gold on a historic basis.
The largest of these in the UK is FTSE 100 listed Randgold Resources (LSE: RRS), which is an international gold mining and exploration business. The group has impressive forecast earnings growth, with a robust balance sheet to match and is highly correlated to the underlying gold price. The stock is relatively liquid and I believe it is a good way of gaining exposure to the precious metal. Investors may also want to consider researching other top tier gold producers, including Newmont Mining (NYSE: NEM), Barrick Gold (NYSE: ABX), GoldCorp (TSX: G) and Kinross Gold (TSX: K).
Alternatively, investors can trade gold directly through a CFD or a spreadbet or they can invest in a Gold exchange traded fund (Epic: PHGP), which gives a simple and cost efficient way to buy and sell gold like you would an ordinary share through your stockbroker.
This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Gold.
