Gold: What's Really Behind the Record Rise?

10/22/2009 12:01 am EST

Focus: COMMODITIES

Robert Prechter

Founder and President, Elliott Wave International

When prices in a financial market go from sea level to outer space in a relatively brief time, two scenarios are at work…and they both start with the letters “B-U.”

When a precious metal goes from being a popular long-term investment of buy and holders to the quick getaway vehicle of daytraders, two scenarios are at work…and they both start with letters “B-U.”

And when the majority of mainstream pundits see a "new paradigm" in which prices continue to rise indefinitely, two scenarios are at work…and, you guessed it, they both start with the letters “B-U.”

Enter the recent gold rush of 2009, when all of the above conditions apply. Everyone from hedge funds to housewives now hustle to hitch their asset wagon to the rising gold star. Which begs this question: Which of the possible two scenarios are at work—bull or bubble?

Here’s the difference: A genuine bull market is driven by a self-sustaining internal dynamic that's reflected by a host of technical indicators. A bubble, on the other hand, is the result of untenable psychology that could shift at any moment and bring prices plummeting down.

It goes without saying into which category the mainstream experts put gold. Namely, a new bull market that has years—if not decades—more to soar. “Gold will hit $2,000 an ounce,”reads an October 8 Marketwatch. And “Gold has more upside…the metal’s bull run is just getting started,”adds a same-day issue of Barron’s.

I found hundreds of news items that agree about the long-term potential for gold’s uptrend. But not a single one could tell me why the rally would continue, other than because the experts say so.

To know whether a diamond is real, it must cut glass. And to know whether the bull market in gold is real, it must encompass at least one of these four traits: 

  1. A surge in demand that outpaces supply
  2. A falling stock market, which raises the “safe haven” appeal of precious metals.
  3. A real (not imagined) threat of inflation
  4. An increase in value relative to major foreign currencies

Right now, the gold market cannot check off a single one of these items. Case in point:

Supply/Demand ratio for gold from jewelry makers—which comprises 60%-70% of the market—has plummeted to its lowest level in 20 years.

“Safe Haven” Appeal - From its March 2009 bottom, the US stock market has soared 50% right alongside rallying gold prices.

Inflation - As the October 2009 Elliott Wave Financial Forecast (EWFF) notes, an increase in money supply is only inflationary if it is used to raise the total amount of credit. This is not happening, as both bank credit and consumer credit levels are contracting for the first time since World War II.

Gold Rally in Other Currencies - Again, the October 2009 EWFF presents the following close-up of spot gold prices versus gold denominated in foreign currencies such as the Canadian dollar, the Australian dollar, the euro, franc, pound, and yen since 2007.


Click to Enlarge

The major non-confirmation between these two markets is clear, as is the overlying message: If demand for gold truly outweighed supply, then its value as measured in other currencies would increase.

The rise in gold is primarily the result of speculation and a falling US dollar. These are exactly the “untenable” forces that contribute to a bubble, not a genuine bull market. The difference is only a matter of time.

By Robert Prechter of Elliott Wave Principle

For long-term forecasts and more in-depth, historical analysis for precious metals, download Prechter’s FREE 40-page eBook on Gold and Silver. 

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