2013: The End Of Gold's 12-Year Winning Streak

Jan. 6.13 | About: SPDR Gold (GLD)

"I think gold should be a portion of every one's portfolio to some degree because it diversifies the portfolio. It is the alternative money." - Ray Dalio

Ray Dalio is quite an intellectual, and an excellent investor. The above quote sums up the most balanced reason for owning gold (NYSEARCA:GLD): it's historically served as an alternative to easily manipulated fiat currencies. Over the past 12 years, it's well understood that gold has benefited from enormous relative growth in the global money supply, elevated tail-risk, and perhaps even a touch of politics.

Looking ahead to 2013, I'll attempt to construct an unbiased lens through which to look at gold's prospects. This is obviously a difficult task, and a bearish conclusion flies in the face of a 12-year trend that's seen gold rise from $250/oz to almost $1,900/oz. Therefore, it seems reasonable that in order for gold's streak to come to a close, a major shift in the underlying fundamentals will have to take place.

What this piece will not attempt to do is call for a collapse in gold prices, argue that the precious metals complex is in a bubble, or discuss gold's long-term prospects.


A major theme in gold over the course of this bull market has been the metal's tendency to rise in sync with "risk assets," or economically sensitive assets.

The thesis for holding gold has been clear: exceptional expansion of the base money on behalf of the Fed (i.e., balance sheet expansion) adds financial liquidity to the system and pumps equities and commodities higher as interest rates on fixed income securities become negligible. There have been a few exceptions to this rule (most notably during last August's debt-ceiling debacle when gold made its cyclical highs), but funds have rushed to buy gold when the sentiment shifts to risk-on.

However, as 2012 came to a close, something strange happened. Gold and risk assets moved in entirely opposite directions (chart courtesy of Yahoo Finance):

Click to enlarge

The break became clear at the end of November, and this trend has remained intact since.

Of course, this is a small sample size, especially in the context of a 12-year bull market, but this new negative correlation is a major development if it holds. Perhaps even more telling is gold's failure to find support given the relative strength of this recent rally.

In 2012, even the strongest equity rallies weren't accompanied by a sustained rise in Treasury yields. With yields approaching 2% in recent weeks, however, the market may be hinting at a major change in sentiment regarding the need for safe-haven assets. In other words, there is a move away from hedging for tail-risks and a move towards trades that express a strengthening economy.

If gold is no longer attractive in the risk-on environment (i.e., equities and bond yields higher), then gold bulls have a lot to reconsider.


For 2013, it appears sentiment on the economy will be far more positive. We are entering the fourth year of the strongest bull market we've seen in decades, in spite of the lack of retail participation and constant denial (admittedly, including myself). Given the modest expansion in valuation multiples we saw in 2012, it appears investors are finally willing to the buy the story that the economy is actually improving.

Tail risk stemming from the EU is largely off the table at this point. For at least three years now, assets have been steadily transferred from private to public balance sheets, Spain's banks are being recapitalized, even Italy's bond yields have come down from crisis levels. Is Europe fixed? The answer is a resounding no. Yet, the EU doesn't have to be flourishing for the rest of the world to continue to grow, it just has to not blow up.

Mark Dow, PM at Pharo Management approaches the gold market from the viewpoint of investment fund flows (emphasis mine):

"Specifically, a lot of big macro tourists hold large PM positions, and what I believe we are seeing is some of them starting to hit the bid. It is also possible that some of them are also facing redemptions, since those clinging hardest to their PM positions are also those most likely to have been working under the wrong economic assumptions and underperforming all year. So, the year-end dynamic may be exacerbating the pressure we are currently seeing."

This is a particularly interesting observation. In the years since the March 2009 bottom in equities (NYSEARCA:SPY), we've consistently been bombarded with worries about the next catalyst for another collapse. Some of these concerns have been fairly well-grounded given the uncertainty (Greece, major EU financial institution collapse), but the ultimate conclusions have clearly been misguided. In an environment where risks have been highlighted for an extended period of time, the chances of another Lehman-like event are slim. Add in the willingness of the world's central banks to provide emergency funding to distressed institutions, and tail risk fades away.

While many high-profile managers like Ray Dalio and David Einhorn have owned significant stakes in gold and generated strong returns, countless others (Paulson) have blown up spectacularly betting on major economic calamity, and are probably being forced to meet redemptions, and at the very least reconsider their global outlooks.

Others, and I'd argue this analysis is most prevalent in the retail space, have positioned themselves for hyperinflation.

The impacts that Fed programs appeared to have on markets could be seen in the massive swings leading up to and immediately following Fed minutes or FOMC announcements. Yet the Federal Reserve's effects on both the underlying economy and financial markets, at least as investors perceive them, appear to be greatly diminished. The recent Fed minutes, in which some voting members argued for ending QE in 2013, had interesting implications for equities and gold: stocks were rather indifferent to the prospect of no QE in 2014, while gold tumbled more than 1%.

Approaching the fourth year of unprecedented easy monetary policy, we still don't have strong inflation, let alone hyperinflation. Why? While base money has grown parabolically (in the order of almost 250%), it has come at a time of household and major financial deleveraging. Instead of having a reflationary impact on prices, it appears Chairman Bernanke and the Fed have thus far been successful in facilitating deleveraging while maintaining stable prices.

Given the breakdown in the aforementioned correlation and sustained weakness in gold prices following the Fed's announcement of both QE3 (MBS buying) and QE4 (additional Treasury purchases), the thesis that monetary policy will lead to a highly inflationary environment that is conducive to gold prices is in jeopardy.


Five years out, I have little idea what the effects of trillions in balance sheet expansion will be. It remains to be seen how the Fed will go about exiting its position as the biggest bond trader in the world, but there's little evidence that such a dynamic will be catastrophic.

Regardless, a major philosophical shift in the way investors approach the Fed's actions is taking place. In a year where tail risk appears to be mitigated, RGDP growth can reasonably be expected to come in between 2 and 3%, and equities are trading at seemingly appropriate valuations (and will likely produce solid returns), and the public perception about the Fed's importance is diminished, gold could be in some trouble.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.