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Three Reasons Why Gold May be Due a Correction

Written By: Dominic Frisby  |  Posted: Tuesday, July 6th, 2010

After moving above $1, 260 an ounce on Friday afternoon, gold closed the week at $1, 256. It's a new record. And it's no surprise. Governments and central banks have between them created an environment of negative real rates. For example, retail price index inflation in the UK is above 5%. Yet the Bank of England has kept the bank rate at 0.5%. By the time they've paid tax, savers need to find a bank that pays more than 7%, just to keep up. Money in the bank is losing its purchasing power, as the people in charge attempt to devalue the currency. Watching your savings shrink by the day isn't much fun. So people are being driven to find a more effective store of value. Is it any wonder people are flocking to gold? What's driven the gold price to new dollar highs? Higher interest rates are inevitable sooner or later. But, as long as this environment of negative real rates continues, gold will continue to rise. Many - myself included - have been looking for a sizeable correction in the market in order to get repositioned. You normally get one or two a year. But, since late 2008, even the slightest sell-off has quickly been met with buying. A lot of people want to get into this market. It's worth noting that much of the rally we have seen over the past fortnight has largely been a function of dollar weakness. In euros and pounds, gold is trading a few pennies below the highs made on 7 June. So it's not that big a landmark. But looking at the bigger picture, gold, a currency in itself, is rising against all fiat currencies, as policy-makers worldwide debase them. However, there are some divergences that suggest gold might soon suffer some sort of correction. Three signs that gold may be due a correction Firstly, June, July and August are typically weak months for gold. The summer often sees one of the best entry-points (i.e. a low) of the year.

Secondly, even after the rally of the past few weeks, gold stocks are still trading below the highs of December 2009 and March 2008. That could simply mean that the stocks are currently a better opportunity than the metal. But that divergence can often indicate impending nastiness. It certainly did in the spring of 2008.

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