Gold drops, but should you drop it?

Recent drops in the gold market aren't nearly enough to give up on it

By , Guest Blogger

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    A file photo illustration of gold bars taken at the Czech National Bank in Prague. Gold tumbled to its lowest level since early October on December 14, set for its weakest monthly performance since September,but Bonner argues that investors shouldn't back out yet.
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Hey…what’s going on with gold? The dollar up, gold down. When we checked yesterday the price was crashing through the $1,550 level.

Our friend, Dennis Gartman, tells us to get out. Here’s the report:

Gold, in the 11th year of its longest winning streak in at least nine decades, is poised to enter a bear market, according to Dennis Gartman, who correctly predicted the slump in commodities in 2008.

The metal…may decline to as low as $1,475, the economist wrote today in his Suffolk, Virginia-based Gartman Letter. He sold the last of his gold yesterday. Bullion has already dropped 13 percent from the record $1,921.15 reached Sept. 6 and $1,475 would extend that to more than 20 percent, the common definition of a bear market.

“Since the early autumn here in the Northern Hemisphere gold has failed to make a new high,” Gartman wrote. “Each high has been progressively lower than the previous high, and now we’ve confirmation that the new interim low is lower than the previous low. We have the beginnings of a real bear market, and the death of a bull.”

In China, the second-largest consumer, gold imports to the mainland from Hong Kong surged 51 percent to 86.3 tons in October to a monthly record, according to the Census and Statistics Department of the Hong Kong government. China imported more than 300 tons for all of 2010, Yi Gang, People’s Bank of China Vice Governor, said in February.

“Buying of that sort should have sent gold prices soaring,” Gartman wrote. “One of the oldest rules of trading is simply this: a market that cannot or does not respond to bullish news is a bearish market not a bullish one.”

But another friend, Dominic Frisby in London, says ‘not so fast…’

Recommended: Gold: A Test of Mettle

Well, gold is up about 16% on the year so far. So no bear market there.

This compares with an S&P 500 which is ever so slightly down; a FTSE 100 that’s down around 10%; a commodities index that’s also down around 10%; a US bond market that’s up about 17%; and a US dollar which is ever so slightly up.

If we use the definition that a bear market is a market that is down 20% from its highs, then Gartman may well be right. I don’t say it will happen, but there is a very good chance that gold could fall more than 20% from its early September high of $1,920 an ounce.

This would be perfectly normal. Gold has had three 20% corrections since this bull market began in 2001. Once in 2006, again in 2008, and just three months ago in September — yes, just three months ago. If you look at intra-day prices, it fell from a high on 6 September of $1,923 to a low on 26 September of $1,535. I make that 20%.

So, first, I look at the fundamentals for gold. Have these changed? No. If anything they’ve intensified. I won’t go on about them here save to say we are going through a generational monetary [unraveling] and in such a situation you want to own gold. You may well also need your metaphorical tins, guns and bomb shelters at some stage, but I do not have a buy signal on those just yet.

So…in or out? You know our answer, dear reader.

Gold has been going up for 11 years straight. Or is it 12? It needs to settle down. Rest. Catch its breath. And, like a lover, it needs to test its most ardent admirers.

How far would it have to go do to give gold buyers a proper shake-out? Maybe to 1,300. Maybe 1,200. Typically, a bull market retraces nearly 50% of its gain before completing its rendezvous with the top. We don’t know if that’s true or not…it’s just what the old-timers say.

Gold has gone from about $260 to over $1,900. Let’s see, take off half of that gain and you have $1,080. Whoa… Are you ready for that kind of test, dear reader?

If it goes down that much, even we might have to revisit our convictions.

In the meantime, sell stocks on rallies, buy gold on dips.

Bill Bonner
 for The Daily Reckoning

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