Wednesday, 14 May 2014

Relative strength of gold prices

There are plenty of technical indicators working very well for a short time frames: RSI, MACD ...
However when it comes to determining the relative strength over the long haul of the gold price, or that of any other precious metal or commodity, it is more useful to compare to the average of the preceding period. In the following article, a simple moving average over 250 days is chosen, since that generally coincides with the number of trading days in a year.
Graphs last updated on Oct 21, 2016
A moving average over one year filters all hazardous day-to-day variations and retains only a rough trend. This trend of course is delayed.  Whenever gold rallies, it runs ahead of its yearly moving average. As the gold price plunges, it may drop below its 250 dma. As a plunge evolves to a bear market, the gold price may stay below its 250 dma for a more extended period.

Dividing the present gold price by the yearly moving average therefore yields a relative strength curve that averages close to one or 100% over the very long haul. The higher above 100% the more powerful a gold rally is and the deeper below 100%, the more subdued gold prices are during a bear market. The first graph pictures the gold price, its yearly moving average and the relative strength curve since 2008. Clicking on any of the graphs will show their true size and detail.

Gold price (blue) and its 250 days moving average (red) on the left axis. Relative gold strength in % (green) on the right axis. Data from 2008 to end 2014.
The time series used is the publicly available series of the London PM fix.
As we start off in 2008, commodity prices are booming with crude reaching its all time high of $147 and gold breaking above $1000 for the first time in March 2008. Gold is well ahead of its 250 dma and the relative strength graph peaks at above 135%. We now all know what was laying ahead and during the financial crisis, gold plunged to $700 with the relative strength graph giving way and sliding to 80%. There were however less than 6 months between Aug 12, 2008 when the relative strength graph dipped below 100% for the first time and Jan 23, 2009 when it rose above its 250 dma again. During the subsequent 2009-2011 gold bull, the relative strength graph predictably never retreated below 100%. Intermediate peaks reach 127.6% as the initial recovery rally runs out of steam early December 2009. The subsequent peaks don't even reach 120%. When gold finally rallies towards its all time high and double top in August and September 2011, the relative strength curve stalls at 130%. This value is below the 135.7% of 2008 and, as we will see, considerably below that of earlier gold rallies. As the gold price comes off its 2011 peak, the relative strength graph plunges below 100% by the end of 2011. The year 2012 shows a mixed pattern with a recovery followed by a summer trough and another recovery in early autumn.
We therefore focus on a 'mid-term graph' with two major divisions per year and including data since July 2012. This graph is going to be updated going forward.

Gold price (blue, left axis) and relatvie strength (green, right axis) since July 2012, last updated on Oct 21, 2016
Before 2012 ends, the relative strength graph is once more posting below 100%. This is where it has stayed during the entire year 2013, plunging below 75% on June 28. Despite the intermediate failed recovery rallies, the relative strength graph only regained 100% shortly before the early 2014 recovery faltered by mid March 2014. By now, the yearly moving average has been rotating out all higher gold prices dating before the initial mid April 2013 gold plunge. This will make attaining the 100% a technically more feasible quest: all we need is a gold holding a $1294 price tag. But even that didn't work out well as the yellow metal plunged below $1250 early June 2014. A meaningful gold recovery with the yellow metal upholding its 250 dma can eventually make the long term average crawl back. By end June, the 250 dma seems having curbed its bear market down trend. A first step was made, but it's too early for crying out victory. As the summer lapsed, gold kept on meandering around $1300, near its flattened 250 dma level. Relative strength kept changing side. September 2014 again brings more hardship: as gold seemed determined to testing its previous low, relative strength once more dropped below 95%.  On Oct 3 gold closes on Nymex at $1190 ($1195 London PM fix). The 250 dma resumes its downward trend. After a mid October faint recovery, gold plunges early November below $1150, setting a fresh post 2010 low. This further decline is attributed to a relatively stronger USD and to the slide of the price of crude (both WTI and Brent). Though the triple bottom at $1190 has been broken, the decline halts at $1142. Despite violent intraday volatility on Dec 01, the spike down in thin trading hours doesn't set a fresh low. The subsequent gold surge brings the yellow metal back above $1220 during the Nymex session. Gold continues oscillating around $1200 till the end of 2014. During the first two weeks of 2015 gold starts firming, despite the relative dollar strength. The Swiss National Bank giving up the peg to the euro further spurs the gold demand. But once more the rally doesn't have legs to run and by mid March, the December 2014 lows are once more challenged. For much of 2015, Gold has a hard time getting above $1200 lately, and an even harder time staying there. The one-year dma declined below $1200 in August with gold sliding below $1100, relative strength again plunged towards 90. Gold eventually bottomed in December 2015 and dragged along until mid January 2016.  The recent recovery has been fairly swift, yet the yellow metal now trends more or less sideways for over two months.

For the sake of clarity another graph showing the 2015-to-date detail is added here:

Gold price (blue, left axis) and relatvie strength (green, right axis) since New year 2015, last updated on Oct 21, 2016
The 2013 gold plunge was not selling off any gold market peak: that already happened in autumn 2011. During 2012, relative strength had been meandering along 100%. At its June 28, 2013 bottom, the relative strength graph dived considerably below its autumn 2008 minimum. These exceptional coincidences distinguish the 2013 cyclical gold bear market from a mere corrective plunge, typical after any parabolic rise.

Over the long run ...

We now extend the time frame to the beginning of the 21st century.

Gold price (blue) and its 250 days moving average (red) on the left axis. Relative gold strength in % (green) on the right axis. All 21st century data till the present day

The first graph started almost in the middle. We now focus on the first half. The relative strength curve starts off the new millenium with a peak. Barely noticeable on the gold graph, yet a $30 move at $300 gold is equivalent to a $130 jump at $1300 gold. This stunning 10% rally in February 2000 followed a report which made clear the detrimental influence of generalized hedging by producers and of gold leasing by central banks on the gold price trend. That single day rally didn’t however break the back of the gold bear market yet: nearly all of the gains vaporized during the following months. The relative strength curve again slides below 100% later in 2000, to emerge only by mid 2001: the first sign of what will turn out to be a major gold bull run.  Peaks in the relative strength remain subdued at about 1.15, as corrections temporise the rise of the gold price. By mid 2005 the gold bull run accelerates with the relative strength peaking in spring 2006 at a stunning 145%. During the following years, that value will never be equalled anymore. The March 2008 peak indeed halts at 135.7% and the 2011 summer rally halts at 130%, though gold puts down its all time high at that moment.

Back to the 20th century

First observation is the scale of the relative strength curve now extending to 275%: when gold peaked at $850 on Jan 21 of 1980, the relative strength peaked at 259%. This kind of fever would never be repeated since. As gold sells off its 1980 peak, relative strength eventually bottoms below 75%, both in 1981 and early in 1982. The autumn 1982 rally brings gold back from its post 1980 low at below $300 on June 21, 1982 to over $500 by mid February 1983. Thre relative strength curve then peaks at a more common 130.8% on Feb 16 of 1983. This second best rally during the last two decades of the 20th century puts the exceptional nature of the 1980 gold fever into perspective.
By 1985 the high interest rate policy of the FED under Paul Volcker had propelled the USD to the strongest currency. This had become a problem on its own, both for the US, where the bulk of manufacturing industry had become uncompetitive and for the rest of the world, where the high dollar exchange rate implied higher costs for most commodities, making it difficult to keep a lid on inflation. From an international perspective, gold at $300 therefore has a different meaning in 1985 than it has in late nineties. As the USD comes off its high, the gold price recovers rallying towards $500 in 1988.

Gold price (blue) and its 250 days moving average (red) on the left axis. Relative gold strength in % (green) on the right axis. Data run from 1979 till the beginning of 1991
The last graph extends the 1980's decade to the beginning of the 21st century. The gold price had been sliding in the early 1990's, with only a short and weak rally as Irak invaded Kuweit and the subsequent first gulf war. In 1993 gold recovers with its price moving sideways close to $400 for over three years. (Miners and exploreres did remarkably well during those years).

Gold price (blue) and its 250 days moving average (red) on the left axis. Relative gold strength in % (green) on the right axis. Data run from 1979 till the beginning of 2001
During 1997 gold sells off, initially weakening below $350, but by December 1997 eventually dipping below $300. This implies the start of a devastating gold and gold mining bear market extending into the first year of the 21st century. From July 1996 till mid September 1999, the relative strength curve remains below 100%. At best relative strength is flirting with the 100% threshold some weeks during 1998 without ever breaking out. In December 1997, relative strength dipped below 85%. In July 1999, it dipped below 90% once more. Towards the end of the 20th century and extending into 2000 a few false starts of a next gold bull market make relative strength fluctuate more wildly.

Discussion

Rather than identical to 100%, the average value of the relative strength ought to reflect the secular uptrend of gold, mainly due to currency debasement and the resulting inflation. (The two are not always in sync as the last few years have demonstrated.) Going back to Jan 2 of 1973 with gold at $65.1 and the more familiar $1302 while drafting this article, gold has risen twentifold. This is equivalent to an annual rise of the gold price of 7.5%. If gold were to rise at this continuous pace, the gold price would constantly remain at 103.75% of its 250 days moving average. This is the secular average value, which perhaps is a better baseline scenario going forward than claiming that relative strength ought to average 100% and that all excess values during rallies will be paid for by gold falling below its 250 dma for extended periods. The 'baseline scenario' is affected relatively little by the exact choice for the current gold price. With gold at $2000, the annual rise of the gold price would have accelerated to 8.6%, with gold at $1000 it would be retarded to 6.8%. Extending the timeline back a decade to 1963 (when dollar currency was 0.900 fine silver and the $35 peg of gold was not yet questioned too much) doesn't alter anything substantial to the baseline scenario either. It even narrows the resulting interval between the 'optimistic' $2000 scenario for the gold price and the bearish $1000 perspective.

Conclusions

Studying relative strength back to 1979 has learnt us how exceptional the January 1980 rally has been. Relative valuation reached a value (259%)  never seen before nor since. The second highest value was reached on Feb 26 of 1974 with a relative valuation at 162%. Not surprisingly that coincides with the first crude price crisis.
Any comparison you may find using that January 1980 $850/oz peak value as a reference is therefore highly tilted.
Typically relative valuation in a gold bull market and during a major rally does not rise above 150%; the two single exceptions are listed above. The August 2011 rally bringing gold to its last all-time-high concluded at a relative valuation of 130%. In this perspective it was one of the more 'moderate' of the gold bull rallies.

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