Euro Gold Records
Despite Washington and the Fed working fast and furiously to destroy international confidence in the US dollar, it still remains the currency of choice for pricing many international markets. Among these is gold. Regardless of where this metal is mined, it is almost always priced and sold in US dollars.
If you are an American investor, this is great. We have always thought of gold as denominated in dollars and it is hard to imagine any other way of thinking about it. But if you live outside the States, the gold price is a lot more relevant as quoted in your own local currency. Your mind is wired to think in local-currency terms and various investment options are only comparable within this life-long mental framework.
Investors all over the world rightfully consider the relative attractiveness of gold as an investment only through the lens of their own currency. Universally investors are attracted to strong and rising markets in local-currency terms, including gold. But thanks to the US dollar's meanderings, local-currency gold charts can look considerably different from the baseline dollar gold chart.
So what we Americans see on the dollar gold charts is not always what other investors worldwide see on their own. If the US dollar is fairly stable, gold will have similar percentage moves in other major currencies. But if the dollar is volatile, which it has been for 15 years now, it can really impact local-currency gold prices. In order to understand how international investors perceive gold, we have to see it like they do.
At Zeal, we have been watching gold in major currencies for years. We maintain quarterly-updated secular charts of gold in ten major currencies for our subscribers on our website. To see gold like Asian investors, for example, we look at it denominated in Japanese yen, Chinese yuan, and Indian rupees. But for reasons that will become clear in this essay, I have long been the most captivated with gold denominated in euros.
Warp back five years ago, to late 2002. The US dollar bear was already underway, yet few dared call it such yet. The Asian boom was still very young and rarely made the news in the States. The three major currencies of the world were the US dollar, the fledgling euro, and the Japanese yen. Until mid-2005 the Chinese yuan was hard-pegged to the US dollar, essentially just a dollar proxy.
American contrarians, fleeing the brutal 2000 to 2002 bear market in general stocks, were paying increasing attention to the rising gold price. It had stubbornly climbed from $255ish in early 2001 to 330ish by this time of the year in 2002. This 29% rally in the face of extremely difficult market conditions was not trivial, and it started driving exceptional gains in gold stocks during the general-stock bear.
So we American contrarians were feeling pretty good, being blessed with big gains in gold and gold stocks while most other sectors burned around us. But I heard from more and more international investors who asked "what gold bull?" They pointed out that gold may be up in dollars, but it wasn't all that hot in other currencies. They said our US gold bull was really nothing more than the other side of the dollar-bear coin.
They were mostly right of course, yet we American contrarians were still earning awesome returns in gold stocks far exceeding the dollar's decline. Thanks to the international investors' prodding, I researched the evolution of secular gold bulls. They have three stages. The first is currency-devaluation driven, only apparent in the dominant currency. The second much larger one emerges when global investment demand starts chasing gold on the metal's own merits rather than just as a currency hedge.
Enter euro gold. Despite Europe's long history of wars, European investors have had many centuries to accumulate great wealth. And they tend to have a cultural affinity for gold far beyond anything in the US. While gold investing was (and still is) considered odd in the States, European investors have tended to have some fraction of their assets in gold for hundreds of years. They have seen enough change to know that the status quo seldom lasts, and gold thrives during uncertain times.
But while we Americans saw rising gold prices in the early 2000s, the European investors just saw gold dragging along flat. Why should they buy more gold when the metal had done nothing for years? This problem is readily apparent in this long-term euro-gold chart. Euro gold is rendered in blue on the right axis, while the euro price in dollars is shown in red on the left. Note how unimpressive euro gold was prior to mid-2005.
Initially euro gold had rallied nicely, from €286 to €349 by February 2002. But then the US dollar bear really began in earnest, as is evident above in the rising red euro line. Dollar gold continued to rise nicely on balance, but euro gold remained largely flat for the better part of several years. While it tried about a half-dozen times between 2002 and 2004, euro gold just couldn't break out above €350.
This €350 resistance line rendered above became quite vexing. European, and other international, investors had no reason to deploy more capital into gold because it wasn't in a bull from their perspective. But American contrarians have limited capital, less than gold needed to migrate into its next secular stage. Therefore emerging international investment interest in gold was crucial to drive it into Stage Two.
By mid-2004, I was writing about the euro-gold stealth bull. While €350 had not yet fallen as Europeans kept pointing out to me, euro-gold support was relentlessly rising. Often I think investors make a grave mistake by ignoring rising lows and focusing on flat-lined highs. The rising euro-gold support was creating an ever-higher base off of which a successful €350 assault could eventually be launched. Such a breakout was inevitable based on the relentlessly rising support.
I even went so far as to predict that the real €350 breakout would mark the dawn of the Stage Two gold bull. Realize that the euro was only born in early 1999, so €350 was effectively an all-time euro-gold high. Once it was decisively surpassed, European investors would get excited about gold again. They would start to bid it higher at a faster pace than the dollar bear. Since investors naturally chase momentum, nothing drives interest in buying like new all-time highs.
Finally in mid-2005, the fabled €350 breakout happened. It was one of the most exciting times of this entire gold bull since international investors would finally start believing it was more than just a dollar bear. Sure enough, as expected over €350 once Europeans started chasing gold, the metal quickly soared. It sparked this bull market's first Stage Two upleg, the massive one running from mid-2005 to mid-2006.
Thus in a very real sense, euro gold's fortunes steered the entire global gold bull! This becomes more clear when you realize that this euro-gold chart is also essentially a US-dollar-neutral gold chart. The change in gold's price behavior between before international investors really got involved and since really couldn't be more striking. This euro-gold chart clearly shows this Stage One/Stage Two break in mid-2005.
From June 2005 to May 2006 during its first Stage Two upleg, euro gold soared 65% higher! It ultimately climaxed near €561. This upleg has a couple important attributes to note. First, and most obvious, is its sheer steepness. It was a totally new phenomenon without precedent within this gold bull. But interestingly back in the early 1970s, during the last Stage Two, there were four such enormous uplegs averaging massive gains of 71% each! So we are definitely due for more than one today.
Second, for the first half of its huge 2005-2006 upleg, gold rallied higher along with the US dollar while the euro retreated. For the second half this situation reversed, with gold still rallying while the dollar weakened and the euro strengthened. Gold was finally liberating itself from the shackles of currency mirroring. Investors all over the world marveled at rising local-currency gold prices and wanted to buy the metal for its own investment merits.
Since gold tends to thrive when general stocks are not, Wall Street has never been a fan of gold. So shrill cries of "bubble" emerged all over the financial media by the May 2006 interim highs. While gold's ascent was indeed steep, certainly a mania hallmark, its behavior since proves it wasn't in a bubble. Since bubbles are purely speculative with no fundamental drivers, after bubbles collapse prices often return to or near their pre-bubble starting point.
As you can see above though, euro gold did not. It did correct sharply initially but it soon bounced into a new high consolidation centering around €475 to €500. Such high levels would have been unthinkable not so long ago in the pre-€350-breakout days, but now they are normal. High consolidations after parabolic rises only happen if there is good fundamental reason for prices to stay high. Gold was certainly not in a bubble, but merely adjusting its baseline price to reflect growing global investment demand.
It is also provocative to consider that once again euro gold is carving a wedge pattern similar to that of 2002 to 2004, rising support and flat resistance. Today euro-gold's high-consolidation support is rising at a steeper slope than it did in 2003 and 2004 and is now approaching €500. The flat resistance on top is largely perceived to be near €550, which is a nice round number but not technically precise.
This final chart zooms in on euro gold's high consolidation since early 2006 to help better illuminate euro gold's current situation. The wedge-like chart pattern and similarities between several years ago and today are much more apparent at this scale. Note that euro gold has been climbing on balance despite the rising euro, showing gold strength outpacing the euro's gains (and US dollar's losses).
Since it is always the highs that capture everyone's imagination, there we'll start. In May 2006 euro gold surged over €550 for the first time ever. It spent two trading days at these lofty levels ultimately hitting its all-time closing high by that time of €561 on May 11th, 2006. But since this happened to be right at the apex of a long and powerful upleg, a correction was due to bleed off excessive greed. Euro gold plunged 20.4% in just over a month and left €550 far behind.
But euro gold soon stopped falling and started grinding higher on balance in its high consolidation. While its interim highs didn't approach May 2006's yet, its strength was still readily evident in its steeply-rising support line. The longer I study the markets, the more important I think the trends of lows become. They can tell us a lot more about a bull's fundamental health than the trends of highs.
Why? At major interim highs, speculators and greed tend to run rampant. Prices are more a reflection of this temporary sentiment than true underlying global supply and demand. But at major interim lows, speculators and euphoria are nowhere to be seen. Because of this, fundamentally-sound price points are much more likely to emerge out of the noise at these interim lows. Euro gold bounced along up its support because it had a fundamental reason to do so, not because speculators were rushing to buy it.
The net effect of this rising fundamentally-driven support is euro gold is tightening ever closer to its perceived €550 resistance. Where €550 seemed impossibly lofty the first time euro gold hit it, it wasn't all that far from support by this past September when euro gold really started rallying again. Euro gold crept above the €550 line for the second time in history in early November. This second attempt was far more impressive than May 2006's.
In November 2007, euro gold spent seven consecutive trading days over €550 initially compared to two in May 2006. It also hit a new all-time record high, €569 on November 7th, 2007. While this was exciting, it apparently didn't last long enough for European investors to start buying gold again en masse since euro gold soon witnessed a minor 6.4% pullback. Since then it has briefly climbed back over €550 several more times, getting more comfortable with this key psychological resistance level.
And this is what high consolidations are supposed to do. By having a price trading sideways-to-higher over a multi-month period of time, investors get comfortable with the new high price levels as being normal. This establishes a solid technical and psychological base from which the next major upleg higher can launch. The longer a consolidation lasts, the more normal the prices feel and the better the base established.
In euro gold's case, €550 no longer seems all that high anymore. And €500 is now the bottom of its trading range. A material and decisive breakout above €550 is not hard to imagine technically. It won't take a lot of investment buying of gold to drive euro gold into territory never before witnessed. This is a really intriguing prospect because it may very well mark the launch of the next Stage Two gold upleg.
Back to the history discussed above, recall that the first mighty Stage Two upleg didn't launch until euro gold broke above its long-vexing €350 resistance to convince international investors the gold bull was real. They saw new all-time highs, got excited, and started moving capital into gold. This drove gold higher and enticed in even more capital, creating a virtuous circle. All because an old resistance level decisively fell.
Well, when €550 decisively falls will we see another surge of international investor interest in buying gold? It wouldn't surprise me one bit. Few things captivate the imaginations of investors as much as new highs. Such a euro gold breakout could also coincide with a retreat in the euro itself. If European investors start to get concerned that a euro correction is due, this will increase their motivation to buy gold to ride out any euro weakness.
While this €350 and €550 resistance parallel is interesting, I don't want to read too much into it. €350 lasted for much longer and was a much bigger problem psychologically. Today European investors are already well aware that gold is in a secular bull. But still, the history of gold as an investment is really clear in illustrating that few things drive new gold investment demand like new all-time-high gold prices.
So watching gold in other major currencies is a very valuable tool to help anticipate big new investment demand from investors who view the world in those currencies. Given Europeans' long history of gold investment and their relative per-capita affluence compared to Asians, I still think euro gold is the most important non-dollar-gold metric to watch. It has the highest probability of signaling the next Stage Two upleg.
With euro gold hovering around €550 today, any buying surge in gold would quickly drive it above and potentially lead to a decisive €550 breakout. I suspect this is even more likely given the irrational fears plaguing PM investors today. Despite high and bullish gold levels all over the world, investors are cowering in fear. This is a sharp contrast to a true greed-laden top like May 2006 when everyone still thought gold was heading to the moon. Today's fear-dominated psychology is what we see at major interim bottoms, not major interim tops. Gold is much more likely to power higher than plunge.
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The bottom line is euro gold hit a new all-time record high last month and it has only seen a minor pullback since. If it can regroup and continue higher, it can decisively break out above €550. Since such a breakout marked the beginning of the last Stage Two upleg, perhaps a new breakout will mark the beginning of the next mighty gold upleg.
So watch euro gold closely in the coming weeks and months. Few things motivate international investors to buy gold like new record highs. We just saw one last month, and euro gold sure looks like it is basing high ahead of surging up to another record attempt soon. It should be fun to behold.
Adam Hamilton, CPA
December 14, 2007
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