Wednesday, 21 October 2015

When Will the Price of Gold Recover?

That's a million dollar question, and a question that even a year ago, I wasn't ready to tackle. Having looking at the chart today, it's suddenly all too clear to me, and I like to share that "lucid" moment.

Looking at the 20 year gold chart below, one can easily see that the gold bull market lasted for 10 years from 2001 to 2011.  Instead of relying on some complicated TA theory, sometimes, the simplest approach is the best. So for the 10 years of gold bull market, the simplest and classical technical expectation would be that it would be followed by a 5 years bear market with a fall of 50% in price. Perhaps better be called the 50-50% Rule where the bear market lasts 50% of duration of the bull market, and the price decline is 50% from its bull market top.

20 year gold chart historical
20 year old gold chart priced in USD
(click to enlarge)

Looking at the 5 year chart below, it seems to follow that 5 years bear market nicely, and at the recent price of 1089 , it's only about some $140 away from the 50% drop target scenario.

5 year gold chart historical
5 year gold chart
(click to enlarge)
This 5 year chart shows strongly that the gold would likely it could be on its way to meet both the price target of 50% drop and 5 year bear market.

This gold bear market is basically divided into 4 phases.

Topping Phase
It lasted for 11 months from Aug 2011 to Sep 2012. This was the transition or price-undecided phase where the bulls and bears fought out for domination, and either side was coming up as a clear winner. Many of the bulls or buyers at this phase were inexperienced players who were swept up in the whole gold mania, and decided to get into this market. My mum bought some physical gold during this phase, and you know it should be time to get out of the gold market.

Panic Sell
This phase lasted for 14 months from Sep 2012 to Dec 2013. This was the phase where the bears sold in a panic, and resulted in the sharpest price decline in the 4 phases.

Resignation Sell
This phase lasted for 19 months from Dec 2013 to July 2015.  This is the phase where some bulls that held during the panic sell phase had given up and started to unload their positions. Its selling, and therefore its price decline, is more gradual because there was no panic, just bitter resignation. They sold in frustration and felt being betrayed.

This is the phase we're in right now that started around July 2015. Its dominant trend is sideways movement. We can expect a new gold bull market starts where this consolidation ends.

How long would this consolidation last? I wish I have a crystal ball. Let's look at the trends in the last 3 phases. It appears that each succeeding phase is longer than its last: the 1st is 11 months, the 2nd is 16 months, and the 3rd is 19 months. If this trend continues, this current consolidation phase would take at least 19 months. So the major price reversal won't occur at least as late 2016 or well into 2017. My feeling is that the reversal occurs sometimes around mid 2016, going by the 50-50% Rule. The rule doesn't say anything about the lengths of the 3 such distinct phases, nor in fact there would be 3 phases.

It's also reasonable to suggest that this current consolidation is going to last as long as the topping phase because both are transitional phases that are characterised by a balance of bulls and bears.

During 2016, its price might test the 50% target of 942 (or close to it, say 950). If the USD Index having another leg up before it peaks out in the next 8 months or so, that would likely correspond to the bottom in gold.

Many hopeful bulls called for a price recovery as early as 2013 during the panic selling phase. Looking at the chart, it seems to play out according to this 50-50% Rule quit well so far. It's unlikely we're going to see steeper selling in this phase than the previous 2 phases because all the sellers have already sold, and prices started to look cheap relative to the last bull peak.

So if everything plays out based on this scenario, it's time to look to get into gold sometimes next year. Overall, I'm more confident about the timing than the price target. The gold bottom in this bear cycle might be 1000. Let's say within the zone of 950 and 1000.

FYI, I bought into gold prematurely in late 2014 (before I did this analysis and sometimes my impatience gets the better of me. Even worse, I bought ABX because George Sorros bought into this company big time. All I can say is, never BLINDLY follow anyone, may they be Sorros, Buffett or whoever. They make mistake just like everyone else). I also bought some more last month.

In any case, I only bought gold producer rather than gold etf or physical gold for the following reasons.

The gold miners tend to lead the gold market. So I think even if the gold price plays out as I outline here, I think I'm not too early for getting on the gold miner at about now.

More importantly the gold miners are much cheaper than gold as the chart below shows. This chart displays the ratio of the price of gold mining companies collectively (as measured by HUI) relative to the price of gold, and it shows that the gold miners haven't been this cheap relative to gold prices for a long time. This is a historical low point for gold miners. In other words, gold miners are far more oversold than gold, and so it follows that valuation of gold miners are far lower than gold. If you consider gold is cheap, then the gold miners are in fire sales prices.

Hui to gold ratio chart

The gold mining industry as a whole is instrumental to the recovery of price of gold. As gold price drops further, more and more high cost gold mines become unprofitable and they will have to shut down. Some smaller gold miners would even run into financial troubles because of the rapid drop in price and had to shut down their business completely. As more mines shut down, supply will decline. Indeed with declining gold price, exploration effort will also slow down relative to boom time, either because of decreased incentives or decreased financial resources. Few new mines will be discovered. In short, fewer old mines, fewer new mines.

All these factors will eventually lead to an imbalance of supply and demand that favours the gold price rise. This process takes time, which lasts as long as the bear market. In other words, as the market price corrects, and so will the supply and demand curves, and vice versa.

While I think there's better entry points in the months ahead (and still slightly impatient), but as a longer term investor, I think getting into gold company at this time is reasonably good. I don't need to have the short time-frame precision of a stock trader. Do as I say, not as I do. Okay, don't do as I say. Think for yourself, first.

Of course, nobody really knows the answer of when gold will turn around. We only know after it happens. This is just my 2 cents.

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