Is the Gold Rush Over?

Gold has taken quite a beating lately, along with just about every other widely-traded investment product you can think of–barring the U.S. dollar and U.S. Treasury securities, that is.  The rise in price of the latter two and sharp, protracted drops in stocks, real estate and commodities shows just how much fear exists among traders and investors that an even more significant downturn is in the offing.

Gold has traditionally been the “safe-haven” asset that investors  have fled to when economic and financial crises loomed or caught the markets out.  Gold prices have recently dropped right along with stocks, housing and other commodities, however.  Instead of shifting into gold investments, market participants have fled for the safety of the U.S. dollar and U.S. Treasury debt, just as they did in the “Great Recession” of 2008-2009.

Gold’s recent fall from grace has those who have long derided it as a financial anachronism saying that the gold rush, if not over, is at least coming to an end.  Gold bugs, on the other hand, say it’s nothing but a temporary downturn, a normal turnabout in an upward trend that will resume and carry gold to even greater heights.

Is the great gold rush finally over?

The Bears’ Case

That gold hasn’t risen along with the most recent surge in safe-haven demand is indicative of just how popular and widespread investing in gold has become, thanks in large part to the advent and growth of exchange-traded funds (ETFs).  It’s gotten so popular, in fact, that gold’s long-term correlation with stocks, bonds and other commodities has intermittently, if not typically, turned positive.

Those who believe the great gold rush–now ten-plus years’ running–is over tend to be staunch skeptics of the merits of investing in gold as a currency alternative.  They believe that it’s attraction is nothing more than a holdover from the days when currencies were pegged to gold.  The gold standard ended in 1971 when then President Richard Nixon took the dollar off its peg to gold and allowed it to float against the value of other currencies, thereby ushering in the era of fiat currencies.

Gold skeptics tend to view the recent breakdown in price as a sign that a long-overdue reversal in gold’s upward trend is at hand.  With the end of the Fed’s latest round of  quantitative easing — QE 2 — they contend it’s just a matter of time before the withdrawal of regular and large-scale injections to the money supply will finally suck the wind out of gold’s sails and bring it back down to earth.

A rise in short-term interest rates would have the same effect, they add.  As gold bears no interest, a rise in short-term interest rates would make gold a less attractive investment.

The Bulls’ Case

Gold bugs just as steadfastly maintain that gold remains the ultimate currency alternative and store of value, citing it’s long tradition as a store of wealth, and the the fact that no government or central bank can increase its supply simply by “printing” more gold.

They contend the fundamental conditions that led to the “Great Recession” remain–despite their size and extent, the actions central banks, governments and regulators have taken to date, while they have staved off a financial Armageddon, have failed to deal with the remaining root causes and effects of the crisis.

To wit, there remains an overhang of still largely concealed bad debts on and off banks’ balance sheets, excessive leverage, excessively easy monetary policy and a failure to end the doctrine of “too big-to-fail” banking groups.  Moreover, they add, no real progress has been made to effectively strengthen financial industry and market regulations or enforcement.

Add to that ballooning government deficits and debt levels, and all the ingredients for further currency debasement, as well as the ingredients for another bout of recession and financial crisis, are all present and accounted for, their argument goes.

If another economic and financial crisis is indeed in the cards, if not already upon us gold bugs say, gold will reassert its status as the safest of safe havens.

The Technical Evidence

Gold bulls point to a string of recent hikes in margin requirements for gold futures traded on COMEX as a key causal factor in gold’s recent sharp decline.  By raising margin requirements more than 20% in its latest hike, COMEX exchange officials have made it much more expensive to trade and invest in gold futures.

From a technical analysis perspective, the price of a share in the SPDR Gold Trust (GLD)–by far the largest and most widely held precious metals ETF–has broken down after forming a so-called “double-top” during September.  It plunged through its 20-day and 50-day moving averages and  bottomed out at $154.19 on Sept. 26. GLD traded narrowly between that level and $160 a share to close out the month at $158.06.

That’s just shy of a 15 percent drop from its $185.85 52-week high, which it hit on Aug. 22, in little over a month.  The last time GLD took this severe a fall was in 2008, when it fell from a yearly high of $98.71 in mid-March to a late October low of $84.08.

GLD trend and momentum indicators have been trending downwards since late August.  The moving average convergence-divergence indicator (MACD), which is used to identify price trends, turned negative in late August and its components have been diverging ever since.

GLD’s sharp fall has coincided with a spike in GLD options’ volatility, which is typical of downward moves and bear markets.  The mean implied 30-day volatility of GLD call and put options has been on a steep incline since hitting bottom at 13.60% on July 1.  It reached a high of 37.05% on Sept. 26 before retreating to 33.81% as of end September.

Whither Gold Prices?

Nonetheless, GLD has performed better than the broad stock market indexes and index ETFs.  For the past three months ended Sept. 30, GLD is up 6.13% compared with a 15.53% loss in the S&P 500 and a 13.25% drop in the SPDR Dow Jones Industrial Average ETF.

So is the great gold rush’s end finally at hand?  Rising short-term interest rates and/or a definitive pick-up in economic activity could reverse gold’s long-term uptrend, while further actions by exchange officials to drive speculators and ‘weak hands’ out of the gold futures market could drive gold prices sharply lower over the near-term.

Yet while the near-term picture isn’t pretty or positive, the fundamental factors that have led to gold’s unprecedented bull do still exist.  Near zero short-term interest rates, ongoing weakness in the banking sector and sputtering economies have supported the gold rush for going on 11 years now, and it doesn’t look like those conditions are about to change anytime soon.

Add to that the prospect of another round of quantitative easing should the U.S. economy tank, the EU sovereign debt crisis worsen or some other crisis develop in a major economy somewhere around the world, and gold still looks like one of the best investment options among a decidedly ugly group of candidates.