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Gambling on Gold - Is it Time to Buy?

In an interview with Small Cap Power, the interviewer asked whether it was was an opportune time to buy gold. AT that time the US Congress was in a stalemate over raising the debt limit. There were daily increasing fears about debt defaults in Europe. China was entering a slowdown and the mood was pessimistic.

It seemed that gold values could go either way with no way of telling whether it was more likely for gold to increase or decrease in value. It seemed a large gamble to purchase at that point in time.

With hindsight, this observation was correct. Commentary in May 2012 after the New York Hard Asset Show said that "catching a falling knife can cut you badly". Purchasing gold bullion in the last year would have hurt your portfolio.

Now it is time to revisit this question of whether gold bullion is a good investment.

Technical Indicators

Gold reached a high in September 2011 of approximately $1,900. As usual, when the trend is strongly up, investors jump on the bandwagon because everyone believes the sky is the limit. It turned out that gold then fell reaching a low of approximately $1,550 in early 2012. This came as a series of upward and downward movements in the price, with the lows being progressively lower, and the highs being progressively lower. This is considered by technicians as a very bearish sign.

Gold then recovered somewhat in February 2012 but again thereafter showed weakness. Since then it has traded in essentially a downtrend and recently has traded in a narrow channel between $1,550 and $1,650. During this period, gold had a triple bottom. That means that on three occasions it reached the low of previous trading, but did not breach that low and instead bounced up. A level of $1,550 seems to be strong support for the price of gold This is considered by technicians to be a strong indicator of future upward momentum.

Another very positive indicator for technical analysts is if the trend has been strongly upward for a lengthy period and then moderates. By falling from $1,900 to $1,550, gold retraced approximately 18%. This is considered a normal event and within the realm of normal. Gold then meandered within these narrow band limits between $1,550 and $1,650. Technicians consider this very positively and it is thought than this is a period of consolidation and gathering strength before the next big upward movement.

In the last few days, gold seems to be testing the upward limit of this downward channel. If it breaks through, then technicians feel it is a very positive indicator.

However, although many signs are positive, this upper level of the channel has not yet been penetrated. So the indicators have yet to be proven correct.

Isn't charting wonderful?

Other Positive Factors

August 21, 2012 ETF Daily News - The S&P 500 (INDEXSP:.INX), Dow Jones Industrial Average (INDEXDJX:.DJI), and Nasdaq 100 (INDEXNASDAQ:.IXIC) indices have reached pivotal "make it or break it" levels that may lead to a tug-of-war between bulls and bears and a bit of volatility in the coming days. Specifically, each of these indexes are now testing key resistance of their multi-year highs that were formed in March or April of this year.

The Dow Jones Composite Index has reached a similar high. The TSX has broken through the 200 day Moving Average. It seems that in spite of continued bad news from Europe, the slowdown in China and India, the wars in the Middle East, the unemployed in the USA, and a wealth of other bad news, stocks markets are reacting in a positive way.

Let's examine specific demand for gold.

Demand for Gold - Jewelry

The two largest gold buyers in the world are China and India. Both had lower demand during the second quarter of this year. According to the World Gold Council's (WGC) quarterly Gold Demand Trends report, total demand was 990 tons, which was about 7 percent lower compared to the second quarter of 2011. When you look at the jewelry sector, China and India remains about 50 percent of the world's total gold demand. However, this quarter's jewelry demand of a little more than 400 tons makes it one of the weakest periods in two years.

However, if you look at Chinese demand for gold over the first half of 2012, the level was 410 tons -- about the level that it was this time last year over the same period. Total bar and coin demand was also weak in China and India compared with the rest of the world. So demand has weakened slightly, but remains strong.

Demand for Gold - Central Banks

Central Banks over a sustained period were net sellers of gold, although in a controlled and agreed manner. This reversed about 3 years ago, when they became net buyers. The official sector continued its gold buying this quarter. The WGC reported that central bank purchases hit a record high since the official sector became gold buyers three years ago. According to the WGC, if this trend continues over the remainder of 2012, central banks will be entering a "new territory" of gold buying that has not been seen since the early 1960s and since the end of the Bretton Woods System in 1971.

According to the firm's quarter-end data, official sector institutions purchased 158 tons of gold in the second quarter--or about 16 percent of the quarter's total gold demand. During the first half of 2012, central banks have acquired 254 tons of the metal, which is about 25 percent higher than the same period last year, says WGC.

The WGC says Kazakhstan, Mexico, the Philippines, Russia, Turkey and Ukraine are buyers. According to the GGC, central banks have been motivated to add gold mainly as a currency hedge. Central banks want to increase their weightings in reserve asset portfolios and diversify away their dependence on U.S. dollars--and possibly the euro. There's also a belief that sovereign debt is no longer considered to be a "risk-free" asset, says the WGC.

How to Interpret This

Gold appears to be at one of those inflection points. Just recently, the gold price has moved above its 50-day and 100-day moving averages, which is another indication of potential strength for the metal and an additional reason to believe that gold may be an attractive entry point. There goes that technical analysis again.

For the adventuresome, the risk/reward ratio has swung positive again, and the adventuresome, gold may be attractive. For the rest of us, waiting for a breakout above the trends may be more appropriate. A smaller profit, but a surer thing is the way to keep your portfolio healthy.


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