(13 votes, average: 4.85 out of 5)
Loading ...Folks,
A host of bearish variables have prompted me to take a bearish stance towards precious metals.
I offer a number of reasons for my contrarian bearishness on gold/silver here:
1) In spite of recent robust demand in the physical retail market (as has recently been reported by the press), gold is 13% off 52-wk highs. Silver, which has also seen a surge in retail orders, is down 50% since March 2008.
2) The financial markets just had their worst week in history and gold has been unable to push higher. Quite the contrary, the yellow metal sold off sharply on Friday.
3) Silver is now a whopping 50% off its highs. Historically, gold has moved in tandem with silver. The current disparity could spell trouble for gold and the inflationary thesis.
4) News of surging retail demand is a huge red flag. The masses are usually propelled by fear, irrationality and a sense of panic. In 2001, when gold was selling for $250/oz, one was hard-pressed to find anyone lined up to purchase gold. In fact, at the time, the mere mentioning of gold as an investment option at a party, would have sparked laughter. Now, all of a sudden, the retail masses are buying gold in droves. And how do the metals respond? They are unable to go higher.
I have two personal specific fundamental theories as to why gold is not marching higher:
1) Despite the reported increased ownership of gold by the retail community, major institutions are responsible for the lion’s share of investment demand. Right now, with redemption requests hitting money management firms across the globe, these participants are most likely selling into resistance.
2) The credit crunch has spread across the global. Banks are winding down their loan programs and/or putting up more stringent conditions on lending. Financings are drying up. Juniors and major miners are scrambling right now to forward sell as much gold as they can to satisfy lending consortiums and secure enough credit to move ahead with mine development in the next 2 years. This puts a lot of commercial selling pressure on COMEX futures.
In addition, I believe we are in a deflationary environment.
Here’s why:
1) Commodities (oil, nickel, copper, zinc, tin, etc) have been dropping precipitously
2) Global growth is slowing (China, for example, has seen 4 straight quarters of steady GDP deceleration)
3) Credit markets are seized up right now, curbing the velocity of money
4) Housing prices continue to slide
5) Unemployment is rising across the globe, putting downward pressure on wages
6) Banks continue to write off assets
7) Increased debt issuance by governments to pay for bailouts and assistance programs will vacuum money supply out of the global monetary sytem for now (US Treasury has been especially aggressive in the last few weeks with its auctions. This activity is manifesting itself in the tape via a surge in the dollar).
Bottomline: take the actions of the herd with a huge grain of salt.
INFLATION? MAYBE LATER, BUT NOT NOW
I respect Jim Rogers’ thesis that we are due for hyperinflation. Bernanke is an astitute student of the Great Depression and undoubtedly knows that the most effective way to mitigate a deflationary depression is to engage in highly reflationary policies. These may come in time.
However, I believe we are not there yet. Right now, any reflation, will be offset by rapidly falling asset prices.
I believe we could, at best, be in a late 1974-like environment with a weak market and gold/silver peaking. Except the price-action is more worrisome now for precious metals than in that period. From 1974 to 1976, silver experienced a correction from $6/oz to $4/oz (a healthy 33% retracement over 2 years). This time around, in just 8 months, silver has been brutally dumped, dropping from a March peak of $20/oz to a Friday, October 10 low of $10/oz. This type of virulent sell-off appears to mark a medium trend reversal. In the 1974-1976 period, oil hardly retraced, setting up the necessary inflationary backdrop for a second gold and silver bull run. This time around, we have oil in a spiraling downtrend.
Like platinum (inextricably tied to the fate of the ailing auto industry due to the fact that 51% of its demand is assigned to catalytic converters), silver has been punished for its industrial properties as of late. About 45% of silver demand comes from industrial applications. The vertiginous sell-off in silver is not the work of a cartel or government-sponsored conspiracies. It is the result of understandable wholesale selling by investors fleeing the “global growth story” — and its deflationary repurcussions. Gold bugs should be concerned by the behavior of silver, because there is no historical precedent supporting new highs in gold with silver lagging so far behind.
Here are some charts of interest.
Gold (1973-1979)
http://www.chartsrus.com/chart.php?image=http://www.sharelynx.com/chartsfixed/GC1976btm.gif
Silver (1971-1979)
http://www.sharelynx.com/chartsfixed/SI1974.gif
Oil (1920-2002
http://www.chartsrus.com/chart1.php?image=http://www.sharelynx.com/chartsfixed/CRUDEOILlt.gif
Gold looks like it is on the verge of cracking after Friday’s sharp sell-off, despite all the retail interest.
Check out this chart of gold performance in the 1970s.
http://www.chartsrus.com/chart.php?image=http://www.sharelynx.com/chartsfixed/GC1976btm.gif
The 1974 to 1976 period is interesting in that it presents precedent for a deep correction (at least 50%) in the context of a larger bull market for gold (assuming we are still in one). Gold plummetted by about 50% from $200 in December 1974 to $100 in September 1976. By mid-1976, everyone had given up on gold (including the same type of mom-and-pop retail investors that are buying gold in droves right now). And, at that point (when the wall of worry was at its highest), gold turned around and began to stage its meteoric ascent.
One must tread with cautioun, however, expecting a 1976-1979-like rally in gold. even in a benevolent inflationary environment, it took gold two years of correcitve consolidation before it could attack new highs. Now, we have a contractionary credit environment and plummetting commodities prices. The case for a deep and protracted sell-off in gold looks very likely.
Bull markets don’t work if everyone (particularly the retail investor) is scrambling to get long at the same time after a multi-year run. Quite the contrary, bull markets need to climb a wall of worry. We don’t have that right now with gold or silver. When the newspaper guy down your street tells you he is stocking up on gold, you probably should be a seller.
SHORT-TERM SETUP IN GOLD / WEAK SECTOR
In the Short-term, gold looks like a good short with a stop above its latest pivot highs (on the GLD, that would mean a stop at 92).
Recently, gold and financials have been negatively correlated.
On July 15 of this year, UYG reversed and rallied sharply for a solid week until July 23 while GLD turned around and moved lower.
On Friday, the UYG (financial sector ETF) put in a high-volume reversal day ahead of the G7 summit this weekend. Coversely, GLD reversed on high volume at resistance. This action is ominously bearish for gold.
Precious metals equities are also very weak. This does not bode well for future bullishness in the underlying precious metals.
Names like GG, NEM, SLW, PAAS, AUY all broke down on Friday.
THE TRADE IN HMY
Harmony Gold Mining (HMY), a South African gold miner, received positive mention from JP Morgan last week on the grounds that its costs would be lowered (and its gross margins expanded) by the recent devaluation of the South African rand. The stock caught a 30% up day on October 8 in response to the note, meeting multi-month trendline resistance up at $10.50. I believe the JP Morgan note is meritless. If exchange rate benefits were grounds for bullishness, CVRD (RIO) and Petrobras (PBR) would not be plunging down the abyss on a daily basis. Since July 15, the Brazilian real has gone from R$1.55/USD to R$2.25/USD. So much for that theory holding water. At the end of the day, natural resource stocks are slaves to the performance of their underlying commodities.
HMY is also week fundamentally. In May 2008, the company reported earnings that missed last year’s numbers by 33%. Cash costs also risen sharply (from $479/oz to $591/oz). As per the August Presentation on its website (http://www.harmony.co.za/im/files/presentations/fy08_q4_presentation.pdf), the company expects production in 2008 to be eclipsed by 2007 gold output (1.55M oz. vs 1.75M oz.). All this points to a short-term abberration in HMY’s stock price. I believe HMY should make 52-wk lows soon as the stock begins to catch up to the reality of a weak metals sector and falling gold prices. I would be an incremental short-seller of the stock all the way up to 10.50 with stops at 11.05.
CONCLUSION
The takeaway is that investors should respect the tape. Right now, financial markets are telling a tale of deflation. Until that changes, I would either stay away from gold or I would be short GLD or HMY on strength.
Good luck to all.
-Phil
Phil, Thanks, very nice analysis. 5 stars.
Great stuff, like always. Thanks, Phil.
did you hack my computer? lol. spot on. great post.
Chivas,
Thnx. I’ve been covering the PM space pretty closely lately.
Feel free to post any ideas you may have.
-Phil
Phil,
Very nice analysis. I agree 100% in regards to deflation, however I think that we are going to see the inflation trade arrive more quickly than most are suggesting, because I think that they (IMF/G7) are going to have to arrive at some pretty big numbers rather soon.
If we’re talking about throwing maybe 5-7 Trillion at this, after round one (I’m sure there will be multiple rounds), people will realize that this equation has no other solution than to inflate the currency. The world is in the process of financing the solvency of our banking systems, in exchange for massive inflation – while trying to avoid credit defaults.
Can the inflation trade get ahead of the deflation we are currently witnessing?
Also, don’t forget to hold a little physical Gold, just in case something really breaks. How many surprises have we already had this year? What if we wake up someday and the dollar has been devalued by 20% or more?
That being said, until we inflate, I agree that Gold will get torn down with the rest of the commodities.
As the velocity of money slows down, the dollar will strengthen as it is hoarded (scarcity). I believe that this recent $ appreciation is a huge headfake, and that people will start to seek inflation hedges soon (such as TBT).
I nominate Phil for King.
Great post, fantastic stuff.
So, are you saying the ghetto schwarzes were way ahead of the curve with all the bling in their teeth, gold, diamonds, platinum? Gots to get me some, when prices drop some more. I may even have my dentist spell out ” I bank coin’ in my front uppers n lowers
Nice analyses, but I think gold and silver got sold down on margin liquidations just like the rest of the physical assets/commodities last week.
$850 is my “line of death,” and she tried to close under that level, but it’s held, for now. Currencies are going to go out of favor on a large scale here as Weimarization rears its head in response to this massive gov’t liquidity display.
In the end, there’s only one currency that’s been reliable, and its stamped, not printed.
I have no call on HMY, however.
___
DSB,
You make good points. My only reservation with respect to the argument of immediate reflation is that treasury yields are still low around the world. As long as governments can get away with issuing debt at these ridiculous rates, they will continue to hold auctions (remember, these auctions are deflationary). As for the credit markets, the interbank lending paralysis is less about lack of capital and more about an counter-party risk. In the case of the US, if the Fed or Treasury guarantees interbank lending (a direction, it seems, in which policymakers are looking to go now), credit markets can begin to thaw.
None of this, however, resolves the massive unfunded liabilities and broken pension systems which will begin to weigh heavily on Western governments’ public finances in the next 5 years. This is the next 800lb gorilla to be tackled.
In the case of America, I believe that the trend towards the insolvency of the country’s public finances will lead to a the govnernment’s gradual transition from debt funding to seniorage (ie, monetary reflation). Again, as long as long as yields are this low, there is no need to resort to the printing press. There are still too many people scared of equities and more than willing to accept rock-bottom yields in exchange for “capital security”.
You are right, though. This will change — but I would argue that it will occur at a glacial pace. My rationale is that there are enormous piles of money around the world that have been moved out of equities. The managers of these piles of money are disillusioned by the equity markets and emboldened in their bearishness by the repeated parallels between 2008 and 1929. This money will find sanctuary in a home that is perceived to be safe (Treasuries) right now. It will stay there for a long time, quite possibly overstaying its welcome, until the perceived safety disappears and selling begins in vicious form — as we saw with the equity markets in the last 12 months.
Remember, in the markets, obvious patterns sometimes take years to play out in practice. To cite a recent example: housing peaked in early 2006 but many banks and mortage lenders kept making new highs well into 2007. The Goldman Sachs express train made an all-time high in October 2007!
We do agree on the big picture, though. As the debt/GDP ratio begins to deteriorate and unfunded liabilities (Social Security and Medicare) begin to come due, the US government’s perceived safe haven status will begin to get questioned. Yields will begin to rise, reflecting an increasingly higher perceived risk of default by creditors. New creditors will demand higher returns and the US government will then find it cheaper to print. That is when gold, in my view, will start to run.
-Phil
Oddly, over in Aussie, the land of the plunging currency, almost all of their double-digit gane stocks are in the metals sector.
____
Jake,
NYMEX overnight futures have gold flat right now.
I just want to make one thing clear, though. What I just wrote up above is my read on the variables that play into the gold market. It’s my reason for taking a good risk-reward short shot on gold. I do agree that gold’s day will come. I just disagree as to when that will occur. I have been known to make erroneous forecasts though. However, stubborn is one thing I am not. Right now, gold is guilty (ie, bearish) until proven innocent (ie, bullish) for me.
Naturally, at the end of the day, price is king. If GLD manages to clear 92, I’m a buyer. I do want to emphasize, though, that if gold does manage to push higher, I will be a buyer of GLD or DGP, NOT the miners. If you take the last bull run gold had (from 730 to 1030), most miners failed to outperform the GLD. That’s embarassing. I take it most investors have given up on the miners. Between nationalizations, surpise mining code changes in politically shaky countries, and operating mishaps, it just doesnt make sense to own the miners. That’s my take, at least.
Good luck,
-Phil
Phil,
Good response. I can see the short-mid term bear case for Gold, especially as the “doom” trade unwinds. I wonder how low it goes?
God help you people. Seriously, none of you should be investing in these markets..
Holding gold during deflation and bear markets has been a losers game … gold worked during the Great Depression because we were on the gold standard. Since then the only time gold as worked with a fiat currency has been during times of stagflation/hyperinflation as in the period from 73-74′ when interest rates reached the mid-high teens. If the rescue package has an impact on money supply which has started to pick up steam recently, then given the prospect of stagflation/hyperinflation in the future (12-18 mos ??) as the Fed is forced to raise rates to curb the inflationary impact of the plan we should experience that stagflation and gold will be the perfect hedge …. until then, buy on the dips and hold for the next 2-3 years.
Your argument seems to take both sides of the fence — you say that it’s surprising that gold is performing so modestly considering the apocalyptic circumstances, and then you say that we’re in a deflationary environment, therefore gold should do poorly.
One could just as easily marvel at how well gold has performed in the most deflationary environment in 70 years.
The mom-and-pop market for golden eagles is dwarfed by the futures markets, where the deflation trade has been on with full force for several months. If you had posted this story in June, you would have been prescient, but at this point everyone and their grandmother knows that deflation is here. It’s a little late to short gold.
Moreover, the gold stocks are now pricing in $400-450 gold, by most valuation measures. The gold/XAU ratio is at 8.6, which is unprecedented, even at the 2001 lows (which were also, not coincidentally, the last big deflation scare. It’s entirely possible that the gold stocks are forecasting an imminent gold collapse, but shorting gold stocks at this point could be quite dangerous with that kind of pessimism priced in. A safer bet would be to short GLD while getting long GDX. j
Having stated the above, it’s entirely possible that you are right and that gold will crash to the $400 levels the stocks are predicting as soon as the fear is lifted from the markets. It’s also possible that the gold stocks will crash up to more realistic valuations. Perhaps the thing to do is wait until a reversal to see how gold reacts. If it sells off, look out below.
Great post!
Last week my wife came home and told me that her friend (Japanese ladies…I live in Japan) were talking about buying gold). Now I am not 100% sure that is another reason to consider selling…Japanese ladies are pretty clever, more than the men sometimes.
But anyway, I am selling gold for now.
Will be watching the epic battle raging between inflation and deflation – no clear victor yet but deflation has been winning recently.
.
Be sure to check out the reviews of the books if you haven’t read them:
http://www.amazon.com/gp/product/159196153X/qid=1090963778/sr=2-1/ref=sr_2_1/002-3229916-0100028?n=283155
http://www.amazon.com/exec/obidos/ASIN/0470849827/qid=1090962848/sr=2-1/ref=sr_2_1/002-8434795-3886414
We’ve just had the worst week since 1933. The vix is at 70. Every asset on earth has been thrown out the window due to forced liquidation…
…and you’re looking for short candidates?
This is not the time to short anything. If ever there was a time to be focused on the long side, this is it. Either buy with both hands or keep your powder dry and wait to get long. But the time for shorting is not now.
Speedlet,
On July 15, 2008, we also had a VIX spike (30). Admittedly, it pales in comparison to the volatility in the market now. However, the fact remains that on that deeply oversold market day, UYG reversed and began week-long surge of about 60% from peak to trough while GLD turned around and tanked 5%. Here’s how gold names performed in that July 15 to July 23 period (the same type of period we are in now in which you claim “it’s too dangerous to be short”):
HMY: -12.79%
GG: -15.00%
NEM: -7.6%
AEM: -15.55%
AUY: -16.85%
ABX: -11.58%
In sum, every gold stock I track tanked during that period.
In the past few weeks, in my view, gold rallied not on inflation fears but on INVESTOR FEAR (a lack of confidence in banks, credit markets, and institutions). The actions devised by governments around the world over the weekend to insure lager swaths of depositor money and to backstop interbank lending is a step in the right direction towards restoring confidence.
That is bearish for gold.
-Phil
From 1980 to 2008, 38 years, the money supply increased five times.
What happened to gold?
Zip.
It’s still the same price now as then.
You would have been further ahead in 90 day Treasuries.
hmy up 10.32%
Gold down 2.13%
If you were short these two, you would be down roughly 4% today.
If you were long anything else — anything– you would have been up 11%, just by getting net long the market.
In other words, this strategy has you underperforming the s&p by %15.
This is what I meant when I said don’t short anything on a day like today. Shorting when the vix is at 70 is just getting cute.
Speedlet,
You’re playing Monday morning quarter-back (literally). By the way just in case you didn’t notice, I advocated this short on Sunday. The stock opened at 10.16 today and closed at 10.03. Anybody who threw a few feelers from the open is actually up. No guarantes that the trade will work (stops at 11.05), but I’ve laid out historical numbers and stats to back up the idea. It may or may not work, but that’s how I trade.
This, by the way, isn’t my only trade in the market. I just decided to write a piece on GLD. I’ll also have you know that I’m having a good year, so I don’t need you to write 3 commentary pieces telling me the market is oversold. I kinda noticed that. In case you didnt read my piece, I made comparisons to the UYG and the inverse relationship with GLD, which by the way, held true today. Admittedly, HMY was strong.
If my strategy doesn’t play to your strength, you’re welcome to go elsewhere to look for ideas. If you’re going to demerit the strategy come up with something a little more constructive than the same “the market is oversold, it’s never gonna work, I-told-you-so bullshit”. Moreover, if you have the market figured out and never lose, why don’t you contribute your wisdom to the PG. Maybe then I can swing around and drop a few lines myself — asshole.
-Phil
*ding ding ding*
http://www.marketwatch.com/news/story/gold-could-hit-1500-say/story.aspx?guid={A5996AE5-3242-4F5B-AFF6-1A46E86D44AD}
phil,
I respect your analysis, which is clearly well reasoned and thoroughly researched.
I am wrong much of the time, unlike everyone else who posts on the Internet. So I welcome the opportunity to question my assumptions. I hope to keep reading you here.
You were right, phil. I was wrong.
Gold at 800. It’s all downhill from here.
Credit where credit is due.
Speedlet,
No sweat. I’m less pissed now. As for gold, I see it going significantly lower from here. Think about it: with an oil price at the top end of its range in the mid to late 70s, gold still managed to retrace a full 50%! Now, with oil spiraling south, along with every other commodity (REM’s, PGM’s, base metals) we have no inflationary backdrop. In Brazil, for instance, we are starting to see negative PPI numbers after years of positive readings. I believe we will see AT LEAST 550 in gold.
-Phil_from_Brazil