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Inflection Points For Gold

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By Stefan Wieler and Josh Crumb from GoldMoney.com

 

The full report can be accessed here

as PDF

 

 

 

Inflection

Points

 

 

 

Introduction

 

Gold prices

in USD have rallied strongly in recent weeks, up 18% year-to-date. Gold prices

in other currencies look similar; of the 20 most traded currencies in the

world, gold is up in all of them. In the media and in finance, as with most

exchange-traded commodities, gold is almost always quoted in USD. Hence, as

gold prices in USD moved lower over the past year, many remained under the

impression that gold was in a downtrend. However, when we look at gold priced

in the 20 most traded currencies in the world, in 80% of them, gold showed a

positive performance over the past two years. But does that mean gold in these

currencies has resumed its long term upward trend? In order to find that out,

we have created a set of intuitive rules to define inflection points at which

gold prices decisively change direction. We find that in 55% of the world’s

most traded currencies, gold has re-entered a clear uptrend.

 

Gold prices

in all currencies saw their peaks somewhere in 2011. What followed then was a

more or less sharp decline, but unlike for gold priced in USD, gold priced in

most other currencies troughed in late 2013 to early 2014 and has been trending

higher since. We find that for the world’s major currencies, uptrends tend to

last about 4.5 years on average during which gold prices increase by more than

100%. 95% of the world population does not use the USD as local currency and is

not paid in USD. Saving in gold has helped them to protect their wealth as

their currencies resumed their long-term decay. In the end, this is the path

all fiat currencies follow as their purchasing power declines. Gold is the only

money that has held its purchasing power over time. Indeed it is the only money

that has survived throughout history.

 

While the

USD and a few other currencies have so far been the outliers, prices have

reversed sharply as well. Applying our set of rules to the USD, we find that

gold has entered an uptrend as well as long as prices remain above $1165/ozt,

roughly USD100/ozt below current levels. Historically USD gold uptrends lasted

over three years and pushed gold prices up more than 200%.

 

 

 

figure%201_0.png

 

Inflection Points

 

 

 

Gold prices rallied strongly in recent weeks in all major

currencies. In the 20 most traded currencies, gold is up between 13% and

23%year-to-date (see Figure 2). Unprecedented central bank action had pushed

gold priced in USD to an all-time high in 2011 but since then gold prices

trended down as longer dated energy prices moved sharply lower and USD real

interest rates have recovered from negative levels. (We explain how

longer-dated energy prices and real interest rates affect gold prices here.) In

the media and in finance, as with most commodities, gold is almost always

quoted in USD. Hence, as gold prices in USD have moved lower over the past

year, many remained under the impression that gold was in a downtrend. However,

a quick analysis of the year-over-year performance in gold shows that this view

is not warranted (see Figure 2). Last year, gold was flat or up in half of the

20 most traded currencies in the world. And it’s up with double digit returns

in all of them so far this year.

 

table%201_0.png

 

But does that mean gold in these currencies has resumed its

long-term upward trend? In order to find that out we have created a set of

intuitive rules to define inflection points at which gold prices distinctively

change direction. An inflection point is defined by two things: 1) the first

derivative of the 200-day moving average changes sign; and 2) there must be a

5% price change in the 200-day weighted moving average between two inflection

points.

 

The first rule simply says that the inflection point (the

point where gold ceases to be in a downward trend and enters an upward trend or

vice versa) is where the 200-day weighted moving changes direction, from down

to up or up to down. What is the 200 day weighted moving average and why are we

not simply using spot prices? The 200 day weighted moving average is the

average price of gold in a currency over the past 200 days, where the last day

is weighted with 1, the day before with 1-1/200 and so forth. The advantage of

the 200-day weighted moving average of a price is that the price history is

much smoother than just the daily price. Daily prices tend to be volatile and

change direction all the time. Hence over the analyzed period of 45 years since

1971, we could not positively identify long term trends as there would be

thousands of inflection points.

 

But even with the 200-day weighted moving average, there

will be some shorter periods where the curve changes direction without

establishing a clear trend change. That is where the second rule comes into

effect: An inflection point is only confirmed when the performance of the

200-day weighted average exceeds 5% (or -5% respectively) in the new direction.

In a nutshell, we define the local extrema where prices move in one direction

for at least 5% until the next local extrema. This rule allows us to identify

clear and sustainable trends. Once gold prices in a particular currency have

entered an upward trend, these trends tend to last for several years.

 

Before we show the results for all currencies we take a

closer look at gold in USD. The results for the USD are presented in figure 3.

There have been eight upward trends and eight downward trends since 1971. The

average trend lasted around 2.9 years where up-trend lasted slightly longer

than the average down-trends. The average uptrend yielded a performance of

207%, the average down move a performance of -39% measured by the 200-day

weighted moving average. Despite the recent rally, it is still too early to

determine whether gold in USD has re-entered an uptrend. Should gold prices not

drop below USD1165/ozt over the coming months (almost USD100/ozt below current

levels), a new uptrend will be confirmed.

 

 

 

By choosing the 200-day weighted moving average, we minimize

the number of trend changes, which allows us to identify the long term trends.

But the downside is that inflection points will only reveal themselves well

into the cycle and the inflection points on the 200-day weighted average are

lagging the true troughs and peaks (spot prices). For example, the lasted peak

in USD gold prices was in September 2011, but the 200-day weighted average only

changed trend in March 2012. In order to reduce the time lag we ran the same set of rules

but used a 50-day moving average instead. This time series is more volatile and

hence shows more frequent trend changes. By analyzing the 50-day moving average

indicated that gold in USD has already re-entered an uptrend.

 

figure%202_0.png

 

For other currencies the case is much more decisive. In

euros for example, the 200-day weighted average made a low in June 2014. The

respective trough in the spot price was in December 2013. Since then prices

moved up 33%. The picture is similar for gold priced in Canadian dollars, where

prices are up 34% since the low in 2013. If historical performance is a good

indicator, these trends will continue to last for another two years and should

push gold prices substantially higher.

 

figure%203_0.png

 

 

 

Applying these rules to the 20 major world currencies (20

most traded currencies according to the Bank of International Settlements), 55%

are now thoroughly in an uptrend (see Table 1). Of those currencies where gold

is still trending down, both the Hong Kong dollar and the Chinese yuan are

quasi pegged to the USD, so that shouldn’t come as a surprise. Excluding those

shows that in 2/3 of the world’s major currencies, gold is in a sustainable

up-trend. Table 1 shows how gold in the 20 most traded currencies has performed

through the up- and down-cycles since 1971 (some currencies with smaller price

history show shorter time-frames). On average there were eight up- and seven

down-trends. The up-trends lasted 4.5 years on average, the downtrends only two

years. Gold prices in their respective currencies were up anywhere from 133% to

several thousand % on average during an up-cycle, but only down between -24%

and -40%.

 

TABLE%202_0.png

 

Gold has undoubtedly been a better store of value than any

currency over any prolonged period in modern history. After the sharp price

rise in the aftermath of the 2008-09 credit crisis, gold prices in all

currencies went through a period of consolidation. We believe, this was partly

because gold prices overshot to the upside and had to correct. In addition, the

sharp decline in energy prices has created negative headwinds for gold prices

in all currencies. These headwinds seem to be mostly behind us as longer-dated

energy prices have now reached unsustainable levels. (See our previous report

on this topic here.)

 

Gold prices in most currencies have thus resumed their long

term upward trend. 95% of the world population does not use the USD and is not

paid in USD. Saving in gold has helped them to protect their wealth as their

currencies resumed their long term decay. In the end, this is the path all fiat

currencies go as their purchasing power inevitably declines. Gold is the only

money that has held its purchasing power over long periods of time and indeed

is the only currency to have survived through history.

 

The USD and some USD-pegged currencies have been the

standouts of late as they appreciated vs other currencies as well as gold for

the past few years. However, with gold prices now firmly higher, gold in USD

has likely re-entered the uptrend as well. Our historical analysis implies

there is much more upside still ahead.

 

 

 

 

 

 

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