Gold's Next Resistance Levels

Gold closed in New York this past Friday at $567.40. The day before it closed at $572.50, which was one of a string of new 25-year highs achieved by gold in recent weeks.

Gold has now closed above $500 each day since December 22nd. What's more, it has closed above $500 in 42 of the last 44 trading days. In short, it seems safe to conclude that gold has 'blown through' $500, a level which had provided resistance for twenty-five years.

The $500 area will now provide support for gold should there be any downside reaction to test underlying buying demand. But I do not expect any test of support to develop at this time because there is a lot of money waiting on the sidelines to buy gold. In addition to this potential buying power, another factor needs to be considered here.

A lot of people are short gold, which is explained in a new report released this past week by Cheuvreux, the equity brokerage house subsidiary of Credit Agricole, the huge French bank. This report is going to be a big factor in the gold market for months to come because of the report's conclusions and also because of Cheuvreux's leading position - it has some of Europe's top analysts and is highly respected globally for its research.

This report validates work done by various analysts that has been published by GATA (see www.GATA.org). Some of my past analytical work is mentioned in the Cheuvreux report.

Note that the report's executive summary says:

"We are raising our mid-cycle gold price estimate to USD 900/oz from USD 750/oz and see the possibility of a spike to USD 2,000, or higher. Covert selling (via central bank lending) has artificially depressed the price for a decade.

Central banks have 10,000-15,000 tonnes of gold less than their officially reported reserves of 31,000. This gold has been lent to bullion banks and their counterparties and has already been sold for jewelry, etc. Non-gold producers account for most and may be unable to cover shorts without causing a spike in the gold price."

The above two paragraphs clearly explain why there is a huge short position in gold. It is this reality described in these two paragraphs that has been driving gold higher the past several weeks. It is probably safe to conclude that a short squeeze has already started, given the way gold has been trading in recent weeks.

More importantly, as the market begins to understand the dynamics at work here - i.e., that the gold price has been "artificially depressed" for years by central bank lending - people will be taking a fresh look at gold and buy it because they will see that gold is still relatively cheap and undervalued. This new buying will put more pressure on the shorts. Consequently, the probability remains high that a significant short squeeze in gold will develop in the weeks ahead.

One last point. A short squeeze in gold is very much like a short squeeze in a company's stock. The only way the shorts can cover is to buy shares back from people who hold them - new shares are not going to be issued just to bail out the shorts from their losing position. It's the same thing in gold. The only way the shorts can cover is to buy gold. Gold cannot be created out of thin air to get the shorts out of their predicament. The shorts have to go into the market to buy physical metal. And they are indeed doing that as evidenced by the surge in London Bullion Market Association clearing volumes. There is now a good possibility that the gold price will explode as well. Short squeezes cause prices to 'spike'.

Given the above, let's look at where gold's next resistance levels are likely to be. These are presented on the following chart.

This chart shows that resistance levels 1, 2 and 3 are behind us. Level #4 comes in at $715. That resistance level is followed by #5, which is the all-time record high closing price of $825. After that there is no historical resistance level, though one could reasonably expect that a 4-digit gold price may provide some resistance, if for no other reason than the psychological impact likely to arise from $1,000 gold.

But please remember the key point of this analysis. Gold is not rising; instead, the dollar is falling, which is made clear by the following chart.

Gold still purchases basically the same amount of crude oil that it has purchased at any time since the end of World War II. But a 2006-dollar purchases only 1.8% of the amount of crude oil that a 1945-dollar purchased. Any guesses as to how much crude oil a 2007-dollar or 2008-dollar will purchase?

I ask this question to focus attention on the main point of this alert. Gold may spike upward in the near-term because of the short squeeze that appears to be gaining momentum, but if this spike occurs, don't lose sight of the big picture. Namely, gold's purchasing power is consistent over the long-term, while the only consistency offered by the dollar is the ongoing debasement from inflation that erodes its purchasing power.

Published by GoldMoney
Copyright © 2006. All rights reserved.
Edited by James Turk, alert@goldmoney.com

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