Friday, December 11, 2009

Gold...Bubble or Continued Bull Market?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

The following is an article I wrote in my newsletter, Street$marts, last week. For the blog, I had to choose between gold and the topic I actually wrote about, Dubai. I thought the latter was more timely, which is debatable.

Gold and the dollar have been headline news in the financial world for the past few months. Since the metal and most commodities are priced in dollars, they tend to have a strong inverse relationship (move in opposite directions) that has strengthened since the financial crisis began in 2007.

Back in February at $990 and many times throughout the summer, my analysis indicated a negative for a variety of reasons, not limited to the fact that deflation was the real enemy and inflation would not be a problem any time soon. Additionally, far too many investors were becoming almost giddy on the metal's prospects at the same time that smart money was positioning for weakness. Historically, those are some of the ingredients that lead to a substantial pullback, even if the ultimate path is higher.

While gold was being favored around the world, the U.S. dollar became a pariah as mounting trillion dollar budget deficits as far as the eye can see and a 24/7 printing press was certain to equal continued devaluation. But as I saw it, that was the stuff that bottoms are made of. When absolutely no one wants to own something. And I was wrong, as you can see below.

Once gold exceeded the peak it made in March 2008 at $1035, it was difficult to remain negative and a neutral, at worst, stance was taken. So here we are, with the same evidence of an impending decline for months and all we've seen are higher and higher prices with fewer and more shallow pullbacks.

Does this pattern at all seem familiar?

It should! It's the same behavior we saw with oil in 2008 (see chart below), housing and mortgage derivatives 2006, technology in 2000 and dotcoms in 1999. It's called a BUBBLE and one is definitely developing in gold.

The thing about bubbles is that they are incredible to ride, but NEVER end well. They last a lot longer and go much, much further than anyone can possibly imagine. But the steeper the incline, the steeper the decline. Remember when crude oil went from $50 to $147? And then from $147 to $34 even faster as you can see below?

Last week, I said, the best thing gold can do now to preserve its healthy bull market would be to digest its enormous gains over a period of months, sawtoothing its way to the $1000 area before resuming the upward climb in mid 2010. But if we don't see much weakness between now and January, the odds favor an even more powerful, parabolic acceleration to a final peak in 2010 that would likely see $100 move in one day towards the end.

Over the past week, gold has corrected more than $100, taking some of the froth off the market, while at the same time, shaking out some of the weak handed speculators. Only an immediate return above the recent highs would likely reignite the bubble-esque behavior, but I would not rule it out in 2010.

As investors, there are many ways to play the gold and precious metals markets, from liquid to illiquid and from conservative to aggressive. Please feel to email me with any questions or comments at

Until next time…

Paul Schatz

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