Gold Price Bubble?

Maybe, but not yet... EVER SINCE the mid-term election results were tallied and
the dimensions of the Federal Reserve's second round of Quantitative Easing were
laid out, Gold Prices have gyrated wildly, says Brad Zigler at Hard Assets
Investor . A precipitous plunge, followed by a screaming ascent to new nominal
highs, left traders reeling. The moves in the Gold Price prompted analysts to
wonder anew if the gold market was staging another run-up, or was in fact
stumbling about in the terminal stages of a decade-long bull run. Talk of a
bubble burst in Gold Prices also resurfaced. The bubble question's been debated
for some time now. Analysts often compare bullion's run to the dot-com mania of
the 1990s, and, as we'll see, there are some startling similarities. The endgame
for the tech stock bubble featured extremes in the magnitude and the velocity of
stock price changes. In early 2000, prices ran up fast and, just as quickly,
collapsed. In the wake of the recent QE2 announcement, the Gold Price certainly
spiked sharply higher, but bullion's path hasn't yet traced the pattern that
usually precedes a blow-off top. Emphasis on the word "yet". Look back at gold's
bull run, starting in 2001, and compare it with that of the Nasdaq Composite in
the 1990s... Presently, gold's bull market is 118 months old and, based on the
London morning fix at October's end, has bestowed a 501% gain on bullion
holders. Some 118 months into its run-up, meantime, the technology-laden Nasdaq
Composite had appreciated 713%. At that point, the Nasdaq was just four months
shy of its ultimate top – a gain of 1,130% from its January 1990 base. And
those last four months were some of the Nasdaq's most volatile. The index
exhibited an annualized volatility of 19.3% over the preceding decade, but its
standard deviation ballooned to 34.5% in the terminal trimester of its bull run.
Gold's volatility over the past decade has remained a relatively quiescent 17.0%
per annum, less than that of the contemporaneous equity market. The new highs
scored by gold, too, aren't running far ahead of bullion's average price. When a
market reaches toward a frothy apex, prices will typically advance faster than
average, but the recent highs in the Gold Price have fallen well within the
metal's normal volatility pattern. Over the past decade, Gold Prices have
notched new highs when bullion has traded 17% above its 10-month moving average.
New highs in September and October were just 12% and 15%, respectively, above
the metal's average price. So history suggests that gold will need an even
steeper price climb to form a proper bubble – the final inflation before the
inevitable pop. And November's trading action to date certainly seems to be
setting the stage for such drama. Spot gold spiked 3.1% higher in the first
third of the month, as volatility rose to 23.2%. That Gold Prices will
eventually fall is a pretty much a given. The question is when, and from what
level. Let's deal with the "level" part first. A large contingent of gold
aficionados believes that gold will converge upon its inflation-adjusted high
set back in January 1980. A London fix of $850 projected through 30 years of a
rising Consumer Price Index would make that target at $2,253 presently. Now, go
back to the Nasdaq model. The rise in the last four months of the index's 2000
run-up was a whopping 58%. Bullion would need to notch a 69% gain to hit its
inflation-adjusted high by the 122nd month of its bull run. Doable? One can't
say it isn't. How probable, though? Well, to significantly dull gold's luster,
the fundamentals that set gold on its present course – namely the debasement
of the US Dollar, together with the uncertainty and fear precipitated by global
terrorism –must be mitigated. Bullion's run isn't being fueled by a dearth of
metal, but rather out of a lack of faith in the greenback. That faith isn't
likely to be restored in four months' time. The evidence of gold's utility as
the "anti-dollar" is scribed by its price trail in the world's other reserve
currency, the Euro. Since the common currency launched in 1999, gold's price has
climbed at a compound annual rate of 14.6% in Dollars. Gold's appreciation in
Euro terms has been just 12.9% per annum since 1999. The new highs bullion is
now lodging in dollars just aren't being matched by new Euro records. Gold's
scored a new high in the Eurozone currency back in June and hasn't yet exceeded
it. Now let's consider the "when" part. There will likely be early warning signs
of a shift in gold market dynamics before a blow-off occurs. The so-called
"smart money" – the hedge funds and institutional accounts that have been
driving investment demand for bullion – may ditch gold, out of fear of
diminishing returns or simply to exploit better opportunities in other markets.
When the hedgies leave, the gold market will be left to smaller speculators. In
fact, we've seen a bit of that already. The net speculative length of the Comex
gold futures market fell in October, after weeks of unabated expansion. Long
positions held by all speculators – large together with small – dipped by 9%
in time for Halloween. Parsing the trader commitment data reveals the outflow
was actually an exodus of money managers from the gold market. The number of
funds holding long positions in gold futures fell 9%, while the fund runners
lightened their net long contract commitments by 12%. But while institutions and
hedge funds exited the market, small speculators increased their long gold
exposure. There was a 5% uptick in the size of small speculators' net long
position in October. So the influx of small speculators filling a vacuum left by
large traders typically speaks of a late-stage bull market. It's the "little
guy" that gets in last. We ought to see even more dramatic evidence of retail
Johnny-come-latelys in the marketplace near the ultimate top of the gold market.
That's not to say funds have lost all their interest in gold, though. Of the
extant positions held by money managers, 94% are still long. At one point
earlier this year, virtually all gold positions held by funds were purchases,
but now other opportunities beckon to fund capital. This exodus of capital also
showed up in the SPDR Gold Shares Trust – the world's largest Gold ETF –
where we've seen a dissonance between prices and recent capital flows into the
trust. As Gold Prices climbed in early October, GLD's Money Flow Index dropped
precipitously – a harbinger of the price break that came at midmonth. The
Money Flow Index is a volume-weighted measure of the capital flows into and out
of a security, and indicates the strength or weakness of a current price trend.
When the MFI moves in the same direction as prices, it confirms trends and
indicates they're likely to continue. Divergence signals a likely change in the
price trend. In the week following Oct. 15, Gold Prices slumped nearly 4%. While
prices have since recovered, the SPDR Gold trust's MFI still remains relatively
weak. We'll see more divergence in GLD's Money Flow Index when gold's ready to
top out. So what next? Taking into account the forgoing, odds are there's still
some time left in gold's run. And, as the Nasdaq bubble demonstrated, gold's
biggest gains are likely to be made in the immediate run-up to the market top.
This knowledge is likely to tempt more adventurous investors to jump aboard the
gold train for the last leg of its bullish journey – however long that may
run. The cautious among them will monitor early warning indicators for signs of
topping. There's still money to be made from gold in the near term, I believe.
Just how "near" is "near" is anybody's guess, however. Buying Gold today? Make
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