The contrarian view: Gold

Gold prices have seen a remarkable run up from its 2008 lows on speculation that the loose monetary policy enacted by central banks globally and the European debt crises will debase the fiat money system leading to an erosion of trust in paper money.

Thoughts from the trading floor

Gold is considered the ultimate safe-haven of one’s wealth. Throughout history gold prices have moved reflecting the global macroeconomic trends at that time. As a result it has largely always maintained its purchasing power parity and this characteristic has established the market’s reputation as the safe haven for the rich who wish to preserve their wealth during periods of uncertainty.

The $700 lows made in 2008 reflected the global market theme during that period- market participants were deleveraging from commodity trades and most participants feared for the total collapse of the banking system. However, the key turning point for the market occurred during the 1^st half of 2009 when the stabilisation of the banking system lead participants to question the long term strategies put into place by central banks across the globe to achieve this. The key decision by the US Federal Reserve to embark on the quantitative easing policy led markets to fear the potential debasing effect this would have on the USD and the erosion of trust in fiat currencies. This set the Gold markets on a steady course higher for much of the year. This year the European debt crisis has served to accelerate the trend higher, which resulted in the market hitting all time highs around the $1260 mark.

Of late we have started to see a worrying trend develop in the macroeconomic data across most developed countries. The removal of small amounts of fiscal stimuli has steadily led to a worsening of macroeconomic data, raising fears that the developing economies are heading towards a deflationary environment. Going back to the fact that gold maintains its purchasing power parity with goods across the economy, a gradual fall in those prices should lead to a gradual trend lower of the gold market. This would be contrary to the forces that have led the market higher since 2009, where participants feared that the erosion of trust in fiat currencies would lead to runaway inflation over the next several years. Thus most participants long of the market currently are looking for the price of gold to continue to trend higher. This is how they are positioned and leveraged. If the realisation that the developed economies are heading towards deflation hits home, we would expect the market to sell-off as only the investors looking to preserve their wealth look to hold gold bullion as a wealth preserver, as opposed to leveraged longs looking for rising gold prices to create wealth. This may lead a dramatic market correction that sees gold back to the sub $800 mark.

Bull View

The bulls will hope that the current market trend continues. Historically periods of deflation have been rare and Bernanke himself believes that the ability to continually print more money means that periods of deflation under a fiat money system should not occur theoretically. Bulls will hope that global central banks will continue to “print money” and thus further debase the fiat money system, leading to higher gold prices.

Bear View

Futex View

We believe that the contrarian bearish gold scenario is a lower probability but very high impact trade. In order to express this view, we would favour either looking for extreme exhaustion points on up-side move to sell into or using the options markets (buying put options).

Tags: futex, learn to trade, Macro, market profile

This entry was posted on Friday, July 23rd, 2010 at 12:12 pm and is filed under Macro Overview. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.