Why are investors so pessimistic about the gold price?

Gold has been in a correction phase from $730 for just over a year and at the moment of writing hovers around $650 an ounce.

What happened is that the equity market correction last May also brought a sharp fall in the gold price, and reminded gold investors that the same funds that pulled money out of shares could also pull money out of precious metals, and quickly too.

A year on and there are two opposing views from a technical analysis viewpoint, and unfortunately both are strongly backed by this very reasonable science.

Double top?

First that the gold market has formed a classic double top and the US dollar to which it is generally inversely correlated a double bottom.

Therefore gold must be going lower and the US dollar higher. The terrible recent performance of many gold stocks tends to reinforce this pessimism but could be a self-reinforcing phenomenon.

Secondly there is the view that the market for precious metals has been correcting from an overbought situation last summer, and has formed a flag formation pointing to a continuation of the upward ramp in the gold price.

Perhaps then we need to ignore technical analysis and declare a draw, and get back to fundamentals. Have any of the factors supporting the five-year gold bull market gone away?

Let us try to make this case. Oil prices may have peaked last summer and commodities could be on the way down due to a worldwide economic slowdown. Yes, but gold is a precious metal and not an industrial commodity driven by the economic cycle.

Try again, what about a bond market implosion followed by a global equity slump this October? Would gold not then get dragged down as funds sold all asset classes? Well, that would be a first in the history of modern stock market crashes as gold has always more than held its own as a safe haven asset class in the past.

Crash protection

Indeed, is it not then more likely that in a real Wall Street crash gold would gain and not lose investors? Also it is certainly far from impossible for gold and the US dollar to rally together under such conditions of financial distress with money exiting bonds and stocks.

Besides if we come back to the fundamental view of what is happening in global economics we do not have to visit such a dramatic scenario to see a good outlook for gold.

The world economy looks to be drifting into conditions of stagflation with lower economic growth, and higher inflation and interest rates. This is what typically happens after oil price booms followed by booms in asset markets like equities and real estate.

Back to the 1970s?

We last saw this pattern in the 1970s and the end of that decade was characterized by a spike in the gold price to levels that have still not yet been reached in the current gold bull market.

So perhaps what we have seen in the past year is a repeat of the 1975-6 correction in the gold market before the real fun began, or there is just a little further to go before the bottom.

Making a case for why investors would sudden abandon precious metals in such an economic environment is virtually impossible. More likely many more would discover gold as a safe haven and hedge against inflation, and gold is a narrow market so then the price would only go in one direction.