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Gold and Oil. Into the Abyss?

Gold and Oil Chart
Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

Gold bugs will be pardoned if they are having thoughts of "hari-kari". Gold bugs woke up on November 5, 2014 to another $25 plus drop in the price of gold. Seems that someone found it convenient to dump $1.5 billion of naked gold futures (equivalent to roughly 1.3 million ounces of gold) on the market at around 12:30 AM EST. There are not too many market makers around at that time to absorb the sale. Silver joined the party and at one time, it was down over 80 cents to around $15.20. The dump on November 5 might not have been unusual except the pattern has been repeated on a number of occasions of late.

Since 2011 there has been an ongoing series of gold futures dumps usually in the early hours of the morning when conditions on or around the open of the NY COMEX are thin. The biggest dump was the mornings of April 12 and April 15, 2013 when someone dumped 400-500 tonnes of gold (estimated value at the time of $23 billion) of gold futures (paper) at or near the open of trading in NY.

Gold appears poised to fall into a black abyss. Maybe the black abyss is made of oil as it too has collapsed under $80 and is threatening to fall further. To counter the downward moves of gold and oil something must be going up and it is the US$. Both gold and oil are priced in US$ (see chart - and note US$ is registering an extreme RSI) and they do have an inverse relationship with the US$. The reasons given for the latest decline (and US$ rise) was the Republican win in the November 4, 2014's mid-term elections. It is well known that Wall Street is quite happy with political "gridlock" in the US.

US$ Index
Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

Technically both gold and oil have broken down through what either appears as a descending triangle (gold) or a long symmetrical triangle (oil). Gold has potential technical objectives down to around $950. Oil has potential technical objectives down to around $55 and even down to $40. For gold, this is the second breakdown since the market topped in September 2011 near $1,912. Gold broke down from a descending triangle that formed between September 2011 and April 2013. Potential objectives were down to the $1,180 area. It appears that the objective was fulfilled. The current wave down from $1,255 appears to unfolding as five waves. Even if this wave is complete and a counter-trend rally starts soon there may be more downside later before the $950 objective is fulfilled.

There have been claims that the bullion banks (primarily JP Morgan, HSBC, BNS, Barclays, UBS and Deutsche Bank) have been behind the decline acting on behalf of the Federal Reserve. If there was a purpose it was to protect the value of the US$ even as the Fed conducted three rounds of QE exploding their balance sheet from $800 billion to $4 trillion and the US debt exploded from under $10 trillion to $17.6 trillion in the space of six years since the 2008 financial crash.

There is also a possibility that the bullion banks were spooked by central banks starting to ask for their leased gold back or for delivery of their gold that has been held in vaults in NY, London and even in Ottawa. During the 1990's the central banks had leased out their gold to the bullion banks. The bullion banks or their proxies later sold the gold into the market helping to keep a lid on gold prices through the 1990's. In order to cover short physical positions the bullion banks would need to repurchase the gold at much lower prices than were prevailing back in 2011. What they may not have counted on is the unprecedented demand for physical bullion that has materialized particularly from Asia (China). There has been over the past few years, as many analysts have noted, a massive transfer of wealth from the West to the East.

The price of gold is not determined in the physical market. The paper market (derivatives) determines the price of gold. While the physical market is quite limited, the paper market is in theory unlimited. The falling price has not stopped the demand for physical gold or silver. In a perverse way whenever these dumps take place in the paper market, the demand seems to spike in the physical market. For example, it has been reported the US Mint has temporarily sold out of American Eagle silver bullion coins following huge demand over the past several weeks.

The collapse in the price of gold is causing numerous junior mining exploration companies to curtail operations putting them on hold. As prices continue to fall, high cost producers could be next to curtail operations in order to protect their operations. As gold prices fall below $1,200, many mines become uneconomical.

The gold dump on the morning of November 5, 2014 wasn't the first dump over the past week. As was normally the case the gold dumps consistently took place in the early hours of the morning either before or after important announcements. The Fed announcing the end of QE was one occasion. The surprise announcement of the BOJ for a massive new QE program was another occasion. The Fed ending QE and the BOJ starting QE had the dual effect of suppressing the Japanese Yen and boosting the value of the US$. If one checks the early morning trading of gold on October 29 and 30, 2014 one would discover large dumps of gold estimated to have been between 25 and 50 tonnes of gold.

The recent decline in oil prices has caught many by surprise. Oil prices have fallen roughly 30% since WTI peaked at roughly $107 back in June 2014. Brent crude has fallen roughly the same. Market analysts are blaming it on a glut of oil but oddly in the midst of a price decline Saudi Arabia increased production and then cut prices. Saudi Arabia cutting oil prices even as oil prices fell has raised the ire of other OPEC members. Oil is the most geopolitical commodity in the world and any major change in the oil markets can have percussions around the world. Lower oil prices provides relief for consumer countries (i.e. Japan, China and the US as well as consumers at the gas pumps) but causes a decline in revenue for major oil producing countries where oil often underpins their budgets.

The US has played a role in increasing production going from 8.5 million barrels a day back in July to 9 million barrels a day more recently. Libya has surprised observers by actually increasing production in the midst of a civil war going from 200 thousand barrels a day to 900 thousand barrels a day. On the demand side the IEA was expecting only a 700 thousand barrel a day increase in 2014. The IEA is not expecting much more of an increase in 2015.

Few countries have the capability to cut production. The ones that could include the United Arab Emirates (UAE), Kuwait and Saudi Arabia. Instead, Saudi Arabia increased production to maintain revenues. The Mid-East remains the world's largest oil producer producing some 28.5 million barrels per day. Where production cutbacks could occur is the curtailing of alternative energy sources that includes the Cdn oil sands, fracking, deep water and high Arctic oil. The reality is that they need high oil prices in order to be profitable or to continue drilling.

Low oil prices could destabilize countries. The countries most vulnerable to destabilization are Iran, Iraq (as if the civil war wasn't enough) and even Libya (despite a civil war). But there are a lot differing agendas here. Saudi Arabia and Iran are enemies and from Saudi Arabia's viewpoint, anything that might undermine Iran is good. Iraq is closely aligned to Iran. Shiite Muslims rule both Iraq and Iran. Saudi Arabia is Sunni Muslim. The two sides of the same religion have been at odds with each other for hundreds of years. The religious war has it seems, heated up once again. Iran's budget priced oil at $100 a barrel. Some adjustment may be needed if the low prices persist.

Falling oil prices has a negative impact on Russia. 80% of Russia's revenues come from oil. Russia exports some 70% of their oil. Russia had been counting on $100 oil but are now being forced to revise their budget calculations. Given what appears to be a renewal of the Cold War over Russia's involvement in Ukraine, the US would no doubt be happy to see financial pressure put on Russia. Some have claimed that the price of oil was engineered lower to hurt Russia. The Russian Ruble has also been under severe stress due to sanctions and Russia has used up reserves to support the Ruble as well they have seen some $70 to $80 billion of funds flee the country.

Some other countries that could be destabilized by falling oil prices include Kazakhstan and Venezuela. Like Russia, 60% of Kazakhstan's budget is dependent on oil revenues. Venezuela's situation could turn critical and face economic collapse and debt default. While the US continues to import Venezuelan oil, the two countries have been at odds for years and the US was allegedly behind a failed coup attempt several years ago against former President Hugo Chavez. Nigeria is another country that could be destabilized by lower prices.

While not in the same category Norway and to a lesser extent Great Britain are also dependent on oil revenues. Canada could also be impacted. Oil makes up 20% of Canada's exports and the exports largely go south to the US. Lower oil prices could well have a negative impact on oil sands production and in turn negatively impact Canada's GDP. Plans for Canada to become an energy "superpower" would be put on hold. Tax revenues in Alberta and Ottawa would be negatively impacted. On the other hand lower oil prices could benefit Ontario's manufacturing base.

None of this suggests that oil prices could continue to fall. Oil prices were boosted on November 5, 2014 by an underwhelming EIA report that indicated the add to supplies was less than expected and that there were rumours of an oil pipeline in Saudi Arabia blowing up. But the breakdown under $80 was compelling particularly in conjunction with the breakdown under $90, which was the trigger for the current decline. The decline since the break under $90 has been swift.

Oil and gold, are they both falling into what appears as an abyss? Do both keep falling or do they find support somewhere? It is interesting to note that while gold has broken down in US$ it has not broken down in Japanese Yen or Cdn$ nor for that matter Euros. The chart below shows that gold in Cdn$ is above what appears as a double bottom made in 2013. Gold in Japanese Yen bottomed last April and has been on an irregular rise ever since. It has helped that the Cdn$ has fallen 11% since April 2013 and the Japanese Yen is down 13%.

Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

Maybe the last word on the collapse of gold should be made by the dreaded "vomiting camel" pattern (see next page for chart). No I do not make these things up nor have I ever seen this pattern (Note: it maybe satire, unless you are gold bug). It was presented by a Brian Kelly on CNBC on November 3, 2014 (Thanks Joe for the suggestion). The pattern according to Kelly has a projected "splat zone" of gold down to $700 to $800 even as the upper end of the "splat zone" is around $900. That's not pretty and it is quite the "hurl". Kelly does point out that a collapse to that level could take several months so what the market is currently seeing might well just be the first "splat". In the interim, the gold bugs are no doubt hoping that the camel experiences "splat back". That would certainly beat falling into the abyss.

Dreaded Vomiting Camel Pattern in Gold
Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data


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