Friday, June 28, 2013

Price of gold back to pre-recession levels?

Despite the fact that the price of gold ($GLD) has already dropped significantly, traders have to take into account that the price of gold may drop even further, back to price levels seen before the great recession.

Gold price last 5 years.
Markets are less fearful

That the price of gold has declined almost a quarter last year, and is now trading around $1,200 an ounce, which is at its lowest point in almost three years, is because the markets are less fearful than they used to be. Fear usually drives the price of gold up. The peak was a little over $1,900 in the summer of 2011, now that's a price drop of 30%. I remember that back in those days there was even speculation that gold could rise to $2,000 an ounce, and that was exactly the problem.


While the price of gold was making higher highs in 2011, the Dow Jones Index failed to make lower lows and was still trading well over 11,000 points in that same time period. This alone should've been an indication that gold was significantly overbought, and is since then in a down trend to pre-recession levels. Mainly because markets around the world are correcting.

Gold price (orange line), compared to Dow Jones Industrial Average (blue mountain). While the price of gold was making higher highs in the summer of 2011, the Dow Jones failed to make lower lows. (chart courtesy of MSN Money)

Should you buy?

Even with the idea that gold may have reached a bottom, I still don't think it's a good idea to buy now. Aside from lower fear level, which can be measured by looking at the $VIX, also the interest rates on bonds rise again. Gold is in a severe downtrend since the beginning of the year, and so far it doesn't look like it's stopping. So even at $1,200 gold is still relatively expensive compared to other investments at the moment.

Also, investment banks don't have a rosy outlook for gold and have adjusted their forecasts in the last few months. Like UBS adjusted their bearish outlook with 10%, as well as Goldman lowered his expectation from $1,435 to $1,200.

Has the bottom been reached?

I think when it comes to gold, and the question whether or not a bottom has been reached - we have to closely monitor the $VIX panic index, as long as that stays below 18 there's a good chance that the downward spiral will continue and gold will be trading below $1,000 by the end of the year. Once a bottom has been confirmed it may be a good idea to add gold again to your portfolio.

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