Precious Metals and the Validity of Technical Analysis – Part 2

17
Feb

Recently the economics site: www.FinanceandEconomics.org published an article on “Precious Metals and the validity of Technical Analysis.”  We completely agree with the thoughts expressed there and in this piece would like to expand on their thoughts here.   Over the last eight years or so, we have seen the Technical Analysis approach to the gold price give incorrect signals, when seen in isolation.   Many times the technical picture pointed down on the gold price in the face of a strong fundamental picture.   We know that this has wrong-footed many gold investors who found themselves waiting for a fall only to see it consolidate then rise.   Over the last few years it has done this more frequently until we find at the Gold Forecaster we approach technical analysis in a way that allows for this and complements the fundamentals.   Of late, some analysts have identified a ‘head and shoulders’ top and forecast the end of the ‘bull’ market in gold and silver, but it has not come, nor do we expect it to come.   The reason the charts have failed to correctly forecast the gold and silver prices so often has been due to the change in the nature of the market, the change in the type of investors, the change in the number of investors and the change in the location of investors.

Part 2 – The Change in the nature of Gold Markets and those that are not Gold Markets

The first part of our series on the validity of Technical analysis, covered the changes in types and location of investors.   It also detailed those markets called gold markets, but which are not directly of fully involved in the buying and selling of gold.   This laid the foundation of why technical analysis has not proved as accurate as some maintain.   Many investors may believe that all one needs to be successful in a market is technical analysis.   We would disagree with that when we look at the markets in gold and silver.

Conditions needed for Technical Analysis to work

There are two conditions that need to be met for technical analysis to work efficiently:

Investor sentiment must be properly reflected in the market price.

With a market as diverse as the gold market, [see part 1 of this series] investor sentiment cannot be properly reflected in the gold price because of the nature of the holders of gold.   In the developed world, an investor is one who buys intending to take a profit at some time in the future, by selling gold.   In the case of the gold market, this is the concept of the developed world investor, but excludes the largest and most important sides of the gold market outside the developed world.

For instance, central banks are not driven by profit nor is it their intention to sell at a point of time in the future.   Emerging nation gold buyers see gold as financial security.   In particular Asia, which includes all the lands to the east of Greece, right through all India and China gold is to be held for the family and ongoing generations thereafter.   These buyers only sell when they believe that the price has gone too high too fast and then they sell with every intention of buying back that gold once a new ‘floor’ price is established after the fall.

In the developed world, portfolio holdings of precious metals are thought to be less than 1%.   This includes the holdings of “non-gold and silver” markets such as futures and options and gold and silver mining company shares.   So in real terms, developed world investors are a very small part of the global gold market.   Most commentary on gold and silver we see is based on the thoughts and emotions of these western investors.  This hardly meets the condition that “investor sentiment must properly reflect the market price.”

Prices must accurately reflect demand and supply.
The equity markets of the developed world usually reflect true demand and supply in the prices of those equities.   It was for these markets that technical analysis was developed.   Usually events surrounding the equity involved moved investors to buy and sell, reflecting the overall prospects for the equity.   In the gold and silver markets, this is not so.   The factors affecting the gold and silver prices are diverse, complex and have little to do with gold itself.   These factors reflect global confidence or lack thereof, the level of globally perceived stability in the developed world, whereas in the emerging world gold is seen as real money to be collected and held for future rainy days.   These motives for holding gold and silver hardly constitute the sort of motives that would fit the criteria needed for technical analysis to be accurate.

A look at global demand shows that the number of buyers of gold is increasing all the time.   With India and China leading world growth through the fundamental development of those nations, the newly enriched middle classes are exploding constantly now and set to do so for several decades to come.   Each of these middle classes follows the wisdom of their elders and turn to gold as a trusted and reliable means of saving.   Even the well-educated follow their elders on this front.   Those who may have been skeptical have been convinced by the rise in gold this century from $275 to close to $1,400 with more rises of a substantial nature expected in the future.   Mum and Dad have been right so far.   This has solidified this type of approach to gold and silver in a part of the world suddenly able to invest usually for the first time for a generation or more.   The percentage of their portfolios held in gold is somewhere north of 25% with the balance [in China] usually held in bank deposits.   The percentage in gold is growing all the time, despite rising interest rates in China.

The developed world’s perspective

It is hard for the developed world to understand this because investors there grew up in a world of a fully developed banking and investment system driven by banks and governments through paper currencies.   For the last 25 years, gold has been treated in the West as an out of date simpleton’s investment that carries no income.   Even after a rise of over five times the gold price is thought of as a strange bubble that will burst at some point.   Bearing in mind that the bulk of the world [albeit only newly enriched] has known gold to be serious money for around 6,000 years.   Their [and in Europe] experience through last century with the paper money of the different governments has thoroughly convinced them that it is not to be relied on for your pension let alone for your estate.   There, government has been changeable and corrupt, and their paper currencies even more so, so who in their right mind would trust them with their old age.   In the West, that lesson is still being learned and could prove a painful one indeed.

Gold not in a ‘bull’ market

So we would suggest that we look at gold not in a ‘bull’ market, but that the currencies of the developed world have been in a ‘bull’ market and have now moved into a ‘bear’ market, as the leading currencies there are being over-printed, so vastly increasing supplies.   Gold, if it is to function in its traditional way, should reflect such an expansion of money by rising in price to reflect that expansion, eventually [there are many obstacles put in its way by governments most anxious for gold to not sit in such judgment].   But gold has and will be the measure of a currency’s value not the other way round.

Can Technical Analysis be used in the Gold market?
Turning back to technical analysis, it is clear that the factors affecting the gold price are too diverse, too large and too complex to be persistently and accurately reflected in technical analysis.   When describing the Asian type of gold buyer, we are loathe to use the term ‘hoarder’ because that implies a certain narrow attitude to gold a myopic uneducated one.   On the contrary, eastern investors have got it right to date.  There historic experience pointed out that eventually currencies would fail as they always have.   We are also loathe to use the term ‘investor’ for the developed world where the term, ‘long-term trader may be more appropriate.

Gold has retained its value through wars, peace centuries and throughout history.  Currencies have lasted only as long as the government that has issued them.   Until 1971 currencies needed the support of gold to retain credibility.   Since then, this support has been ignored and that credibility has lasted only as long as the boom has.   So can technical analysis be useful in the gold market.   Yes it can, but not in isolation.

Where technical analysis is extremely useful is when it is used in conjunction with fundamentals analysis.   Used in their correct proportions, it is possible to receive guidance from both types of analysis that is effective in gauging short and long-term price directions.  But if one has the wrong perspective or proportions then technical analysis will disappoint.

Repeatedly during the years of gold’s rise, technical analysis has warned of a change of trend and a downturn.   But when tempered with the fundamentals, it has warned, quite rightly of corrections.   Most of these have been shorter lived and shallower than indicated, but then adding the fundamental drivers from Asia and central banks and the warnings have led us to expect such shallower falls and quicker rebounds.

What direction is given to the Gold and Silver prices by properly proportioned Technical Analysis now?
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