Gold’s Best Run in Nine Months...Conviction of $1,250:8/8/2010

Gold ended the week with another strong advance. Closing Friday well in positive territory, the precious metal in fact recorded its most consistent bull trend (eight consecutive daily gains) in nine months. If this was the only analysis that was used to assess the strength of the commodity, we would be led to believe that gold was perhaps entering a new phase of a larger market cycle. However, when we take a more critical look at the speculative and fundamental elements of this performance, there is reason to believe that the market’s gains are far more strained than a mere series of daily closes would allow for. And, one of the most accessible arguments against a boundless rally is the pace of gold’s climb to this point. Despite the consistency of the seven-day advance, the metal has only progressed 3.8 percent and has made modest progress in reversing the previous month’s tumble. For comparison, the equivalent run in November scaled 8 percent and developed near the end of a long-term bull wave.

From a fundamental perspective, gold’s hesitation in further is logical. Through the commodities steady climb, we have seen the backdrop of risk appetite fluctuate from positive to negative a number of times. A simplistic association of this commodity playing the role of a safe haven would lead us to believe that this is a break in a critical correlation. This is a mistaken conclusion for two reasons. The first point to make is that gold is not the perfect alternative to a risky asset. It is uncertainty in the stability of the financial markets in general that imbues the precious metal with an abnormal value that directs capital to the already expensive asset. The high volatility of exchange rates and the risk of liquidity troubles for normal investment assets highlights the metal’s unique position in the market. That being said, gold is not nearly liquid enough to stand in as its own currency; it is not acceptable payment for most other assets (you can’t easily buy stocks with gold for example), it is exposed to high volatility along and it is heavily influenced by speculators and buy only funds.

The other consideration for gold’s deviation is that risk appetite trends themselves are ill-supported. Though we have seen equities climb this past week to new two-and-a-half month highs, the advance has been choppy and the test of new levels has depressed rather than amplified momentum. If we look at the market in context, most growth-dependent assets are attempting to retrace losses suffered earlier in the year and are therefore currently drifting within a broader range. This leaves the capital market more or less range bound rather than carving a distinct trend. Considering additional purchasing for gold will come more and more from long-term sources, the draw of a meaningful trend is imperative at such heights.

Looking ahead to next week, we have to consider both the catalyst for underlying risk trends rather than short-term economic and speculative implications of event risk. Looking at this week’s economic offerings, there are more than a few indicators that can supply short-term activity; but the underlying current will be significantly altered by few releases. From the mix, the European GDP numbers are perhaps the most influential figures. Not only is this a reading of expansion, it will define Europe’s ability to survive austerity. - JK