Is Gold As a Safe Haven Just a Myth?

Isn’t gold supposed to be a haven in times of stress? you know, real money? What happened then? why didn’t gold skyrocket to $2000 oz.? if it isn’t going to go up when the world’s financial market is in meltdown, when is it going to go up? The answer deduced from market history is that gold’s role as a safe haven is simply a myth.

It speaks to gold’s weakness in this market that it bucked the seasonality trend that I pointed out for the month of September. The Philadelphia Gold Bugs Index (HUI) - the only index which is comprised of only gold stocks - started and ended September at pretty much the same level.

My favourite indicator to time the gold market is the k-ratio. To understand how, check out the previous link. Here is a long term chart:

The k-ratio held almost constant, treading sideways for five years as both the numerator, gold stocks, and the denominator, gold prices, kept pace with each other. Because I was using this indicator to time the gold market, I lost some money because I didn’t see a fundamentally attractive opportunity at those prices. While it was painful to watch this historically reliable indicator, it has once again proven its merit. This is probably what people went through when it continued going lower and lower in the late 1990’s and 2000.

So what accounts for the collapse of the k-ratio? While gold has fallen around 4% for the year so far, gold stocks have fallen almost 50%! Believe it or not, that’s actually more than the equity market (S&P 500 Index). A large part of this is probably due to the forced liquidation that we witnessed in the markets last week.

Ironically, now that gold equity prices have fallen this much, the k-ratio is at levels last seen in late 1998 to 2002 - when the gold price was ~$250! The current gold price is more than 3 times that.

The Philadelphia Gold Bugs Index (HUI) has strong support at 175, which would mean the k-ratio to the low 0.20’s and once again, it could set up as a buying opportunity. I really don’t think we’ll revisit the lows that the k-ratio set in 2000 because that was due to a huge asset dislocation (thanks to Greenspan’s bubble).

Comments

[adan:]

nice article, new info for me, though, to be fair, most this info is new to me anyway :-)

hope you do some follow up's

thanks

2008 Oct 17 08:56 AM

[User 30121:]

Hey Babak, if you can't figure out why PMs (particularly gold and silver) are tanking in price, then there is no hope for you. You see, the answer to anyone who pays attention to what is going on in this market KNOWS the reason: Simply, its MANIPULATION. How these miraculous DROPS in the price of gold on essentially the same day at the same time, is lost in your analysis?????? C'mon, just look at the short selling going on. Get real, man. Wait until the s..t hits the fan on these bank(s) shorting. When it happens, and it WILL happen (soon), the projections of Merril and others at $1500 an ounce for gold will be a LOW BALL figure! Remember one thing, four digit gold (and possibly silver, too) is not the question, its what will the first digit be...that's the BIG question! Buy gold/silver if your smart!

2008 Oct 17 11:09 AM

[NOWHEREMAN:]

Gold, yes it is a safe haven when viewed in the same context as an Investment in the S&P index over a span of 50 years.

But just like many S&P stocks which have gone bankrupt over that span, many gold stocks have as well.

Gold stocks are affected by many things but most of all by production costs and mine life. Just like all other commodity related stocks.

2008 Oct 17 11:23 AM

[JasonC:]

Gold is in an inflationary brainstorm bubble exactly the same in every respect as the bubble in oil, in housing, in potash, in every category of real asset bid up to stratospheric levels in the course of the present decade. All of them fueled by low rates in the first half of it, and all of them carried to ridiculous excess on speculative fuel, momentum, and ideological nonsense. And every one of them is going to go splat, completely, utterly, totally, with losses of 50-75%.

Gold stocks are just discounting this already, while gold bugs cling to their magical talismans and recite their conspiracy theory nonsense.

No, your bubble isn't different, any more than oil's bubble was different, or the housing bubble was different, or the internet bubble was different, or the Japan bubble was different, or the Hunt's silver corner was different, or the second oil shock was different...

It's a bubble. Therefore, it will go splat. Law of nature.

2008 Oct 17 12:05 PM

[hardnchewy:]

Comments like JasonC's underlie the primary reason intelligent people should own some gold: 6,000 years of human civilization can't be wrong when it comes to gold ownership. Are we any different today than during Roman times? Gold does not appreciate. Rather, it remains a constant of stability relative to fiat money, which, by the way, has never failed to collapse in the history of civilization. The dollar, too, is already following this ruinous path. Shy away from gold at your own peril.

2008 Oct 17 12:50 PM

[JasonC:]

There are no fortunes created by amassing stockpiles of gold over the last 6000 years. Why do you suppose that is?

No empire or state has ever failed to collapse in the history of civilization either. Also, you are mortal.

Governments can and do sometimes hyperinflate, and it doesn't matter what monetary system they are using, they can and will do so if they so decide. The Romans managed a 5000% inflation in a commodity money just fine. They don't call it "debasement" because of printing presses.

Meanwhile all the actual real fortunes you see around you, large or just comfortable, were created by profitable enterprise within modern times and during the present political regime. Why do you suppose that is? Hint, fortunes don't survive major changes of political regimes. Not more than a tiny fraction, anyway.

It takes real productive service to the rest of mankind, in the present, to sustain any present wealth, even at the subsistence level, let alone above it. That is the economic reality, and compared to its soundness, the delusions of misers are insane.

2008 Oct 17 03:38 PM

[Mongoose:]

Gold has not acted as I thought it would ,under these conditions. November to April should be a strong time for the yellow metal. I'm disappointed but will add to my position here. Good luck to all who are whipped by this current down draft.

2008 Oct 17 03:43 PM

[huskerbob:]

JasonC, where to begin? No fortunes of amassed gold? Maybe that's true on Bizarro world, but here on Earth fortunes have been accumulated in gold for thousands of years! Gold is universally recognized as wealth! How many phrases use the word gold to indicate value? How long did the phrase "the almighty dollar" last? Before it was used sarcastically, I mean.
How many oz. of gold does it take to buy the Dow today? One hundred years ago? How about a barrel of oil? How about a ham sandwich? Now compare the cost in gold to any fiat currency.
The Romans proved that PM's are a good store of value. They inflated their currency by diluting the PM content. The PM didn't become less valuable, they simply used less and less over time.
Actual physical gold and silver are experiencing huge demand. It is impossible to buy silver anywhere near the spot price. People are already taking advantage of the difference between the futures and the physical markets by taking delivery of contracts. Let's see how long it will take Comex to end the practice, proving once and for all that the futures price is divorced from reality.

2008 Oct 17 05:04 PM

[The Sane In...:]

Babak, great article man. I will say that I don't really want to own any sort of gold miners, since many of them are very highly leveraged. Although if gold goes on a rout they'll likely do the same, we're in a weird in-between time where gold really hasn't been reacting the way I, or anyone else frankly, thought it would.

I think we're going to have to see some serious threats to the dollar before gold prices go in to any sort of bull market. Right now, from everything I've been reading in major investment news sources, people aren't really concerned about the strength of the dollar, and for quite some time now if you've been holding on to dollars you've seen some pretty good returns comparable to other currencies. Because of this, I don't think anyone sees a short term benefit to holding gold vs. dollars, especially when you take in to account that dollars are far more liquid.

I think that as soon as we see a sustained drop in the dollar (i.e. week plus) and serious questions about its weakness, gold will go on a tear.

2008 Oct 18 05:29 PM

[Tom Bombadil:]

There's no doubt that gold stinks as an investment since it has no return. For me, it only works as part of a policy portfolio where you rebalance into and out of it as the rest of the portfolio goes up and down. You can use other commodities or real estate but gold has historically been the purest inflation play out there. It takes up the slack when your bonds and stocks are dissolving away, then you sell it and put the money back into the productive investments which eventually get back on their feet.

The bit about "all fiat money societies collapse" would be more convincing if there were a society with convertible currency that has been going for thousands of years. Maybe societies that don't adopt fiat money collapse even sooner, before they become noteworthy at all? It's a specious argument at best in my opinion.

2008 Oct 19 02:24 AM

[The Rookie:]

To Tom Bombadii, and all , Its might be true that without fiat money our economy would have collapsed MABEY sooner. I dont kow. The strenth in fiat money is faith and trust, making it much more valueble than gold. We live on it but when that trust is broken and the only way our leaders want to fix it is to throw money at it without the proper regulations needed to keep them honest, then gold is definetly a true store of value. It will go up, thats my opinion though I dont know as much as some of the other gold bugs on the subject. Most of these arguments, gold bugs vs nongold bugs have already been hashed out over and over again.

2008 Nov 19 06:08 PM