Looking at the price of gold, the lyrics of rock and roll legend Tom Petty come to mind - "the waiting is the harderst part". This year has no doubt been an exercise in frustration and puzzlement. The frustration comes about because many investors thought this year was going to the year that gold finally was going to leave the $1000/ounce level behind. Instead, gold has been caught in an ever tightening range for most of this year. The puzzlement comes about because inflation was almost a foregone conclusion by many investors. After all, governments were printing money, interest rates were slashed and central banks were doing all they could to create some inflationary pressures. As is so often the case in investing, consensus expectations seldom come to pass.
The trend lines below show that gold is converging towards an inflection point. We can see that earlier this year there have been some fairly sizeable short term trading opportunities. But in recent weeks, trading opportunities have been more difficult to come by, At this point, perhaps investors would be best served by the old adage “discretion is the better part of valour”. Given that gold has been sought after as an inflation hedge, it seems that the gold market is deciding whether or not inflation is indeed a problem. Apart from the inflation argument, the impact of jewelry demand on gold prices is often underestimated by many investors. Recent data from the World Gold Council shows that as the global economy has been coping with recession, jewelry demand dropped 22% year over year.
To be sure, the future direction of gold prices is very important for investors. If gold prices break to the upside, it will likely be due to confirmation of higher inflationary pressures, a likely rise in commodity prices and more than likely – a weaker US dollar.
If gold prices were to break to the downside, it would be due to increased confidence that economic difficulties are going to be more prolonged and inflationary pressures are going to continue to stay on the back burner for quite some time into the future. No doubt, the two potential outcomes carry vastly different implications for the markets and the broader economy.
