Gold has been going up on rising inflation expectations. There is a story in the investment world about how “printing money” will lead to hyperinflation, or at least very high inflation. Enough people think this is possible as an eventual outcome of the current crisis that as risk assets have risen, gold has risen too as expectations of an economic recovery have fed fears of inflation. As risk assets fell recently, gold continued to rise as Eurozone buyers fled to gold in fear of a euro collapse.

I do not agree that high inflation is a likely outcome at present — deflation seems more likely; I do not think (as do some people at Soc Gen, for example) that deflation is an argument for high inflation; I do not think gold is a good hedge for CPI inflation; I do not think buying anything is a good idea when the price is too high; I do not think putting 5% of your client’s portfolio into gold provides much of a hedge anyway; and so on and so on. But I can’t deny that a lot of people do think these things, or at least are sufficiently spooked by stories that incorporate them that they put a bit of their portfolios into gold. So I have not been shorting gold all the way up.

However, the world is changing. Evidence of deflation is mounting and inflation expectations are falling. This will make inflation less of a fear in investors’ minds. At the same time, the euro crisis is abating, reducing haven demand.

Technically, gold broke downwards from its recent highs, and then broke again. The breakout is stronger for being from a sloped up-trend line. It has since been ponderously retracing the second breakout as other risk assets have rallied strongly, but on low and falling volume. My supply/demand chart shows the chart turning predominantly red at the recent peak, and staying that way — the only day when rising demand was dominant (bright green) failed to carry the price out of the post-breakout range. I have held off shorting it because of the risk rally — another good day for equities and oil, the assets with which gold is most correlated, might have brought the price above its recent little range. Today, however, gold is falling as oil and equities rise. Yesterday an early (for New York) spike carried the price higher, and then it drifted off; today a spike upward was quickly reversed on high volume (see intraday chart). This somewhat allayed my concern about other risk assets dragging up the gold price.

The best way to trade gold in the last major reversal, from March 2008, was on a 10-day breakout with a tight stop — I have used a tight stop here. The intraday chart shows the buying level; the stop loss page shows the stop and limit and entry level. I put the stop slightly wider than 1 ATR so that it could be above 1230. The limit is the right side of 1150 and the 200-day moving average. This is a trade where a big move is possible, so I may take of the profit target if the market moves my way. Another factor in my decision to buy is that the whole universe is already long — at least the speculative net long is about as high as it has ever been.

The nice thing about this trade is that if inflation expectations continue to fall and the risk asset rally turns around, I should make money on gold as I lose on other positions.