Gold sell-off: avoid the bear trap

The gold price has corrected sharply over the last couple of trading days – breaking the strong support zone at $1,550-1,525/oz and heading straight for the next significant technical support point at $1,300.

The immediate catalyst seems to have been the theory that Cyprus would be pressured to sell a large part of its official gold reserves as part of the bailout deal. At less than 14 tonnes though, this was hardly a market-moving event; however, the theory that future bailouts in the EU could carry similar conditions spread, and countries like Portugal and Spain do still have significant reserves. With 2,452 tonnes of gold Italy’s reserves are second only to Germany’s, and the Italian political situation and economic decline is uncertain enough that rumours that this gold might be in play were at least plausible.

All this rumour mongering, together with sell recommendations from major brokerage houses, a weak technical picture, combined with some major Comex dumping (over 1 million contracts or over 500 tonnes) have resulted in the current correction – the largest since the 2008 panic. Underwhelming economic numbers from China might also have played a part.

The usual suspects are all racing to dance on gold’s grave. All the analysts who have been calling gold a bubble since it was at $300/oz feel vindicated once again.

Some gold bulls deserve special praise for their spot-on call. Whether due to their superior technical chart-reading skills, or just years of trading experience, both Marc Faber and Jim Rogers have in recent months been warning about a possible correction in gold. On 2 April Marc Faber warned: “we had an intermediate peak in gold… the correction period is not yet over”. On 4 April Jim Rogers was even more direct: “I expect the price to decline and when that happens I will buy more”.

Both of these legendary investors remain extremely bullish on gold in the long term, as they understand gold’s fundamentals and the monetary policy and debt excesses that central banks around the world are perpetrating.

Corrections are normal in any bull market and should not scare off the patient accumulator. This bull market in gold will eventually end, as the previous one did in 1980-81, but this will not happen until central banks raise interest rates as drastically as Paul Volcker did from 1979 to 1981. Is Helicopter Ben Bernanke’s Federal Reserve even thinking of ending its negative rate policy?

This is a classic bear trap, setting the stage for the next phase in gold’s bull market.