Gold: burst bubble or buying opportunity?

Is the latest sharp decline in the gold price sign of a burst bubble, or just an overdue correction?

Author: Lawrence Williams
Posted: Monday , 07 Dec 2009

LONDON -

Leading up to the latest sharp fall in the gold price, which so far has dropped it back more than $70 an ounce, many nonspecialist commentators have been warning investors that the rapidly rising price was a bubble waiting to burst. Now the gold investor has to decide whether indeed this is the case and the price will come crashing down further, or the fall is a temporary correction opening up the market for buying at prices which may not return back to these levels for some time to come.

On balance we would reckon the latter is the case - much depends though on whether a major buyer comes in to the market - and for major buyer read China or India. It has been accepted that certainly China has been buying gold on dips - although there is little concrete evidence to support this, but the gold price pattern of late suggests that some entity has been doing so. Now the markets have to wait for next week to see if whoever has been doing this jumps back into the market and stabilises prices at the current level, or drives it back to the $1200 level again. If the latter then this is very definitely a sign that the gold bull market remains with us and more new highs will be reached sooner rather than later.

In the way that India's purchase of 200 tonnes of gold from the IMF was the trigger that drove prices up into the $1200s, a combination of news items prompted the recent fall. Better than expected U.S. labour figures, although they only suggested a slowing of the downtrend, not an end to it, temporarily boosted the dollar - and gold on balance moves counter-cyclically to dollar strength; Barrick's announcement that it had completed its gold dehedging programme also suggested that the gold purchases theoretically needed to unwind the hedges had been completed, while perhaps most significantly the Chinese central bank vice governor had given a warning of price bubbles and a indicated also that China was probably not in the market for the rest of the IMF gold on sale. It took a bit of time for these elements to be considered together, but when they were the gold price dropped very sharply indeed losing around $50 in little more than a few hours before a brief small recovery set in just before markets closed for the weekend.

Even veteran gold bull Jim Sinclair, who has a very loyal following, feels there could be further short term falls in price with possible major support - if it gets down to these levels, at $1156 and $1089. (Indeed the price has fallen below the higher of these levels.) Writing on Friday he said "Clearly this economy is bouncing along a bottom and has decelerated its decline, but is doing so poorly in light of the over the top liquidity placed into the world economy. This is how all figures, market related, react in a trend. That is all.... Respectfully, this is gold so if you cannot stand the heat in the kitchen then you had better leave. Buying dollars here has no real fundamental basis other than a few days at best. .... Gold at these price levels will axiomatically become extremely violent."

One of the most interesting articles on the matter has been one by Adam Brochert featured on goldseek.com which suggested that gold may indeed be in a bubble, but that if it is the biggest rises are yet to come and the current correction is only at about 20% of the ultimate peak.

Others talk of a crash back to below $1000, but given the dollar's situation remains dire, the global economy remains in a mess, and perhaps continuing covert gold market support from China in particular, this is perhaps not the most likely scenario. But gold often confounds. A correction in an ongoing rising price pattern seems the most supportable concept for now. The question is how deep the correction will be before it unwinds?