The wonderful gold market. Small fortunes, large fortunes being made this year. Small fortunes being made by the small speculator who can trade just a few contracts. After all, most beginner traders and investors typically have a bullish bias built into them. All they had to do was just keep buying and pyramiding on the way up. As long as they don’t get crazy and attempt to short the market they did fine. They just need to hope they know when the party is going to be over and get out and not attempt to try to catch a falling knife.
Large fortunes being made by the big hedge fund managers. John Paulson made a paper profit at least of $5 billion last year.
This isn’t intended to be another one of those articles that scared people into buying gold. Nor is this an article to explain why you should just blindly pile into gold as a short term or long term trade. If you have read my blog by now, you would know I do not write about such things.
I would much rather talk about and explain the order flow generators, psychology of the market participants, and figure out why the market is moving now, so as to project out possible future scenarios. I love to ask the best trading questions. After all the quality of your life is largely determined by the quality and quantity of the questions you ask yourself and others.
Business Insider has an article on why you should buy gold and dump dollars. It is a few thousand words in lengths. Unfortunately they do not talk about the gold market from an order flow, liquidity, and expectation mindset.
You can read that article or you can read this blog post to find the order flow generators and what is priced in and what isn’t priced in. Your choice.
Bullish Gold Order Flow Generators
What is the extremely bullish order flow scenario that can fulfill the gold bugs dreams of gold to $4,000?
One or a combination of these factors will see gold move substantially higher:
Quantitative Easing 3.0 from the Federal Reserve
Commodity Boom being led my global growth from emerging market economies instead of the western developed economies. What are emerging/commodity economies? They include economies like Australia, New Zealand, Pacific Rim, China, India, Brazil, Russia. Then the commodity boom results in cost push inflation. If the U.S. is lagging behind in global growth, then interest rate increases may not be as fast as in the emerging market economies, thus the dollar will be weak as money is chasing the higher interest rate currencies via the carry trade. Weak dollar, can contribute to rising gold prices.
Inflation/Hyperinflation: If the consumer price index in the U.S. starts to head significantly higher above 5% per year. That unmoors inflation expectations. So if people were expecting inflation of 2-3% per year, but it starts rocketing higher above 5%, people want a way to prepare and hedge themselves for that spike in inflation and/or fear of hyperinflation. So they buy gold.
Currently people are not buying gold because of any inflation fears. That is not priced into the market yet. Inflation is still low and contained in many countries. Just this past week inflation did tick up a little bit, but overall the huge gold surge has not been because the market has been worrying about inflation. Thus, if the market does truly perceive that there will be an inflation threat in the future, then that can generate a lot of bullish order flow into gold, because that is not priced into the market yet.
Sovereign debt crisis: If a debt crisis flares up in a significant part of the world, say Europe, then gold can benefit because there is a component of safe haven bid in there. The safe haven bid can generate bullish order flow.
Mideast geopolitical tensions: If a crisis flares up in the middle east where there is an uprising, or civil war, uncertainty over military coup, etc. Then gold can have a safe haven bid from there as well.
In general, gold bullish order flow generates all involve some sort of: Safe haven bid, Weak Dollar, Inflation Hedge component.
The safe haven bid is currently the biggest component that is driving gold higher. The safe haven bid is coming strangely enough from the falling equity markets and continued unresolved European and U.S. debt problems. In this case the slowing global growth is causing a safe haven bid into gold.
The rise in gold is not because of the weak dollar, at least not yet. The dollar has not depreciated substantially versus the major currencies.
Nor has the rise in gold been because of the inflation hedge component. If global growth slows, demand slows and energy prices decline that will tend to keep a lid on inflation.
What this means is that the huge gold rise is because of only one of the three main themes for gold. Only one of the themes is generating the bullish order flow to cause rising prices. What this means that there is still a lot of potential bullish order flow that can be generated if the other two scenarios begin to play out. The weak dollar and/or inflation hedge component.
So lets say the commodity boom occurs and global growth returns. That may reduce the gold safe haven bid and result in some profit taking. But if the theme of the inflation hedge and the weaker dollar take over, that can generate enough bullish order flow, then prices can still stay elevated and move even higher than what they currently are.
The big scenario that the gold bugs keep talking about involves a stagflation like environment where global growth is slowing, and inflation skyrockets. In that case both the gold safe haven bid and the inflation hedge component will be activated and result in huge bullish order flow. If the dollar is weak during that time as well, that throws even more bullish order flow into the mix. If there are some geopolitical tensions as well throw in even more bullish order flow into gold.
Who Is Crazy Enough To Buy Gold At Current Prices?
Some people wonder who would be crazy enough to buy gold at current prices. There are all sorts of reasons to rationalize why market participants can generate order flow.
There are plenty of trend traders and breakers traders that could be getting in, or pyramiding into gold positions.
Another reason why people pile into gold: When stock investors, traders go to look at the stocks that were up and down at the end of the day, if all stocks have fallen and gold has a safe haven bid, then some of the only stocks which were up are the Gold ETF’s. So some market participants decide to jump in the bandwagon and go long gold.
Am I telling you that traders and market participants that generate order flow can use such primitive methods? Yes, some of the bullish order flow can be coming from the reason above. That doesn’t mean that they can generate enough order flow to prevent a collapse. But I would much rather rationalize some of the price action with the above scenario rather than some hocus pocus mumbo jumbo fibs, moving averages, divergences, etc.
Many investors are unwilling to go short. Thus they are looking for trades and investments to only go long. If all they are seeing is red on their screen and the only up market is gold, some of them choose to pile into the only market that is up for the day.
All sorts of reasons for people to rationalize buying and selling at the prices that they do. Heck there are some people trying to short gold, throwing on a $5 stop loss and hoping for one of those days where gold drops $50 or $75 an ounce. I know of some order flow traders who try to do that. Nothing wrong with doing that. But it is sort of like a lottery ticket.
In order to get the chances in your favor and improve the winrate, then you can’t short blindly. You need to find a reason for gold dropping by that much. Once you have a reason then the trade working out success chances go far higher. It happens maybe 5-10 times in a year. You just need to figure out what day it will happen on by finding the order flow generators. That is if you want to pursue such an order flow strategy.
Bearish Gold Order Flow Generators
There are a few bearish order flow generators.
If the safe haven bid gets removed and does not get replaced by the weak dollar, or commodity boom themes, then that can definitely result in some substantial profit taking in gold.
Interest rate hikes from the Federal Reserve can typically attempt to cause a gold sell off. But the Federal Reserve has signaled low interest rates for several years. And even if they did, the market isn’t buying gold yet for the inflation hedge, so that probably wouldn’t work.
Also there are various fund managers that can be taking losses in other markets and may be showing a profit in gold. If they get redemption requests, they may need to sell a small or large part of their firms gold holdings. Depending on how much they sell, how fast, and how many safe haven bargain hunter bids there exist, gold can buckle and fall under the pressure of that selling.
Order flow and global macro thinking for gold can be fun.