An Update on Gold Bullion

Gold bullion entered into a period of seasonal strength in the second week in July. Gains since then have been significant thanks mainly to weakness in the U.S. Dollar. Where does gold bullion go from here?

Seasonal Influences

According to Thackray’s 2010 Investor’s Guide, gold bullion has a period of seasonal strength from July 12th to October 9th. The trade has been profitable in seven of the past 10 periods for an average gain per period of 4.8%. This year, short term momentum indicators recorded a buy signal on July 10th at $907.30 U.S. per ounce. Short term momentum indicators remained positive beyond October 9th, the average optimal exit date. Profit taking for the current period of seasonal strength is pending. Likely timing of a technical sell signal is this week. Gold also has a second period of seasonal strength from the end of November to the beginning of February.

Technical Influences

The breakout by gold above its all time high at $1,033.90 per ounce at the beginning of October implies a significantly higher technical target. Gold completed a two year reversal pattern with an intermediate term technical target of $1,300. However, its $80 per ounce gain since the beginning of October has been excessive and a period of consolidation is likely. Short term momentum indicators (Moving Average Convergence Divergence, Relative Strength Index and Stochastics) are overbought. The end of the current seasonal trade will occur when short term momentum indicators roll over and record sell signals. Intermediate downside risk is to $941 U.S. per ounce, its 200 day moving average.

Chart courtesy of StockCharts.com www.stockcharts.com

Fundamental influences

Most of the strength in gold bullion is due to weakness in the U.S. Dollar. The U.S. Dollar fell to a 13 month low last week and has yet to show technical signs of bottoming. International investors and central banks continue to diversify their holdings out of U.S. Dollars. The annual $1.4 trillion U.S. government deficit announced last week encouraged international investors to accelerate their efforts to diversify. On the charts, the U.S. Dollar currently is deeply oversold and due for a short term recovery. However, fundamental reasons for the weak U.S. Dollar have not been resolved. Government spending continues to accelerate and deficits continue to grow. A brief recovery in the U.S. Dollar and subsequent weakness in gold will be followed to a reversion to current trends.

Gold faces a barrier to significant short term gains. The International Monetary Fund (IMF) plans to sell 403 tonnes of gold into the market in an orderly manner in unison with sales by European central banks. However, the IMF is willing to negotiate sale of part or all of the gold to one or more major buyers. Negotiations with the Chinese government to purchase at least part of the block are rumored. The IMF has an incentive to liquidate at least part of the block before the end of this year in order to support emerging nations that have suffered unduly from the world financial crisis. A deal to distribute proceeds of the sale could become part of an international agreement on climate change scheduled for negotiation in mid December in Copenhagen. Completion of an agreement to sell the block is the likely trigger for the next major upside move in the price of gold.

What to do

Investors holding gold bullion are in an enviable position. Should they take profits during the current period of seasonal strength that started in July or should they wait until the end of the next period of seasonal strength from the end of November to the beginning of February? Holding between now and the end of November implies downside risk of approximately 10%. On the other hand, holding until next February offers intriguing upside potential. Investors will make the decision this week based on their personal investment circumstances and ability to take risk.

Disclosure: Mr. Vialoux does not own securities mentioned in this report.