Why the Gold Bugs Are WRONG

I get many financial newsletters and investment advisories delivered via the old-fashion snail mail to my home, and even more via email. Although I take the investment gurus’ proclamations with a grain a salt, I still read the information for entertainment and to gauge what’s hot in the investment world. During the past several years, I have noticed an increase in doomsday predictions by the gold-related advisories.

Some are calling for the collapse of fiat currencies, economic disasters and even future wars. According to these gold bug advisories, this apocalyptical scenario will push the price of gold to $5,000 plus per ounce in a very short period of time. I guess this kind of fear mongering sells advisory services but it’s far from present day economic reality. The long-term top is in with the precious metal. We will likely never even see even $2,100 an ounce in our lifetimes. In fact, I think gold has set up for a dramatic downward correction, starting within the next year. There are powerful fundamental and technical reasons for my gold bearish conclusion.

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Here’s the story‚Ķ

Regardless of what the doomsday gold bugs preach, there are three fundamental drivers of gold prices: Consumer demand, Central Bank purchases and the U.S. dollar.

Recently, the prospect of additional quantitative easing programs by the Fed has supported the SPDR Gold Trust ETF (NYSE: GLD) above $150. The reason being is that gold prices are tied to the U.S. dollar. Easing measures weaken the greenback, therefore pushing gold and other U.S. dollar-denominated commodities higher.

As the economic situation in the United States continues to improve for the most part, quantitative easing speculation diminishes. It’s going to take much more than the current U.S. economic numbers to push the Fed into another round of easing. It’s been made clear that Ben Bernanke will need strong justification to step into the fray. Not to mention that QE3 has been talked about for so long now, that it’s very likely it’s already priced into the market. In other words, even if the Fed’s hand is forced into QE3, any reaction in the precious metal may be lack luster.

Next, consumer demand has been downtrending in major markets such as India. India is the world’s largest consumer of the precious metal. A drought, the weak rupee and higher taxation have all contributed to the slowing demand in India. Gold sales to India have plummeted 50 -60% year-over-year since March. The consensus economist view is that gold sales are likely to diminish by 20 to 30% this year.

Finally, Central Bank demand for the precious metal is dropping. In the first-quarter of 2012, Central Bank gold buying was down 41% from the same time last year. This does not bode well for the continued uptrend of gold.

Technically, the bullish picture for gold becomes even direr. Using the SPDR Gold Trust ETF, you can see that after hitting a high of around $190 in August 2011, prices have fallen back and printed a giant double top on the weekly chart. The weekly double top is in the $170 range and was formed in November 2011 and February 2012. Price fell off the double top in April 2012, broke down through the 50-week moving average using $150 as technical support. Double tops are considered very bearish patterns by technical analysts. This becomes particularly true when the time frame is extended to the weekly length.

Risks to Consider: Anything can happen in the commodity world. Although I’m quite confident that gold has printed its highest price for the long term, things can change quickly. Worldwide economic conditions are in flux currently, therefore commodity prices can be extremely volatile in both directions. Be sure to always use stops and position size correctly when trading.

Action to Take — > My analysis makes it clear that gold’s bull run is exhausted. Closing long positions now is a smart move. Remember, you can always buy the position back should my bearish case not pan out. $150 has proven to be strong support for the SPDR Gold Trust ETF. Therefore, I would wait until $149 is broken on the downside prior to entering shorts.