No one knows for certain when the current consolidation in gold will come to an end. However the ultra-loose monetary policy being pursued by the world’s central banks is very bullish for the yellow metal, and once the US debt ceiling has been raised the powerful bull market is certain to continue.
The world’s major central banks are pursuing ever more aggressive measures to stimulate spending, weaken their currencies, and boost economic growth. Ultra-loose monetary policy is ultimately extremely bearish for the value of paper currencies such as the British Pound, Japanese Yen and US Dollar, however it is good news for those holding gold.
We know that there is a 90% correlation between global money supply and the price of gold. We also know, thanks to a recent article by Ambrose Evans-Pritchard in the Telegraph, that real M1 money supply, i.e. cash and overnight deposits, “has recovered briskly from the mid-2012 contraction in Brazil, China, India, Britain, and the EMU-core”. Even in the US where the rate of change has fallen since mid-2011, M1 is still growing at over 11% annually.
Over the intermediate and long-term this increase in the quantity of money circulating will undoubtedly prove positive for gold. However, as the chart below shows, there is also a relationship between gold and US debt.
A 17 year chart of gold & US debt (Click on the chart for a larger version)
Chart courtesy of Bloomberg
The US reached its current debt limit of $16.394 trillion on 31 December 2012, however the Treasury department is employing “extraordinary measures” which will give them around $200 billion of leeway. It is estimated that this gives Congress until late February to raise the debt ceiling.
In the short-term then, the gold market is likely to remain range bound while investors focus on the debt ceiling debate, however once Congress has agreed to raise the limit gold will likely begin to move higher.
We are entering the final phase of the gold bull market
In both Dow Theory and Elliott Wave Theory, a bull market is described as having three primary upward phases, or waves, each of which is separated by a reversal or corrective phase. The third phase of a bull market is when “the crowd” joins the bullish trend, and it is during this final phase that the most powerful advance takes place.
According to respected technical analysts from both fields, gold is currently in the corrective phase that separates phase two and phase three. If this proves to be the case then the third phase of the bull market lies directly ahead of us. The chart below shows a bullish long-term Elliott Wave count for gold.
A 12 year chart of gold showing a bullish Elliott Wave count (Click on the chart for a larger version)
Chart courtesy of stockcharts.com
It should be noted that there are multiple ways to interpret the structure of the gold market and ultimately using the Elliott Wave Principle is an exercise in probability. It is quite possible that the March 2008 high of $1,033, and the October 2008 low of $681 (III and IV on the chart above), actually established the extremities of the first two major waves of the bull market, i.e. I and II. If this is indeed the case then gold is still in the process of working its way upward to major wave three.
In either scenario however, the outlook is bullish for gold.
The next advance could be spectacular
On 6 September 2011 gold reached a new (nominal) all-time high of $1,923.70 an ounce, however it is yet to break above that level. For the past 485 days gold has been going sideways, bouncing between $1,525 and $1,800.
There is a saying that a bull market will do its best to “scare you out or wear you out”, and each time gold has a violent correction followed by a long consolidation, that is exactly what it’s doing. The correction that inevitably follows a parabolic price spike serves to scare away the so-called “hot money”, i.e. the momentum players that enter the market as the price runs up. The multi-month consolidation period – during which sentiment typically turns negative – then causes many investors to give up and throw in the towel.
Far from being a bad thing for gold, these periods of consolidation set the scene for the next leg up and are needed in order for the bull market to continue. There is also reason to believe that gold’s next advance could be spectacular – certainly there is historical president for a powerful move higher.
As the chart below shows, gold reached an intermediate peak of $728 on 12 May 2006, before consolidating for 494 days. In the 6 months that followed, gold increased by 38%, however its advance was interrupted by the onset of the global financial crisis.
Gold reached another intermediate peak at $1,033.90 on 17 March 2008, before consolidating for 568 days. In the 12 months that followed, gold increased by 29%. Then, after a brief pause at around $1,375, gold continued its run all the way to $1,923.
A 12 year daily chart of gold (Click on the chart for a larger version)
Chart courtesy of stockcharts.com
When the current period of consolidation does come to an end, gold could be poised for a considerable rally, likely taking it to around $2,500 an ounce.
Writing on Jim Sinclair’s jsmineset.com today, Alf Field, arguably one of the best gold technician’s, commented that, “Once $1800 is taken out on the upside, the gold chart will look tremendous. A beautiful ‘cup and handle’ base would then provide strong support for a vigorous upward climb in the precious metal… It seems that gold is well set up for a spectacular year in 2013.”
The bottom line
No one knows for certain when the current consolidation in the gold market will end, however when it does it is likely that the yellow metal is headed a great deal higher. A rise of 30% from the all-time high of $1,923 an ounce would take gold to $2,500, and if history is any guide that’s exactly the sort of rise we could see.
In the short-term gold is likely to remain subdued, however once the debt ceiling issue has been resolved the powerful secular bull market is certain to resume.