The precious metals market is attracting much attention, but for the wrong reasons. Over the past few weeks, gold (NYSEARCA:GLD) has tumbled again and again, hitting as low as $1,626 before finishing the day near $1,655 on Friday. While we were excited about gold's potential after the game-changing QE3 announcement, we see little other choice than to recommend selling gold here, and for aggressive investors to think about taking short positions.
The primary reason for our change in recommendation is gold's counter-intuitive response to positive stimuli. When QE3 was announced, we were excited by the prospect of a new bull run in gold predicated by the essentially unlimited printing of dollars. Due to the QE3 announcement, gold ran up nearly $75/ounce to just below the critical resistance level at $1800. However, since then, the metal has done nothing but fall. A chart is shown below.
As can be seen, since the beginning of October, gold has been in a steady downtrend. The most perplexing and scary part of the fall has been the enigma of what exactly would be positive for gold. Since early September when gold was trading well above $1700, the Fed has announced that they will print money in unlimited quantities, starting with $45 billion per month. If that wasn't enough, the Fed added lofty inflation and unemployment targets to their monetary policy 2 meetings later. Even with these ultra-bullish fundamental developments, gold has done nothing but fall.
At this point, with the Fed's all out liquidity deluge, it is doubtful the Fed could say anything more dovish, going out of their way to tell markets that they will keep policy easy until well after the recovery has gained legs. Even with this essentially unlimited pledge of easy money, gold remains more than 14% lower than its all-time high reached 16 months ago.
With a bull market as voracious as gold has been over the past decade, taking 16 months off from making a new high is a red flag, especially when fundamentals have done nothing but go in favor of gold. In 2008 when gold suffered its last prolonged correction, there were big fundamental headwinds in front of gold, namely a surging dollar. Nowadays, traders are giddy to sell the dollar against risk currencies, yet gold still cannot move up.
There is an old saying in trading that when an asset has every reason to be moving in one direction but refuses to, it is a great sign that it is not going to. If we apply this to gold, it is a flashing red sign that investors should not be owning this asset. While everyone from Bill Gross to Peter Schiff and others believe gold is a great asset to own, the price keeps dropping. The reason could be that all these investors have already bought their full allocation of gold and are not willing to or have no ability to purchase more. In such a scenario, gold cannot move up, regardless of the fundamentals.
Compared to 10 years ago or even two to three years ago, the attention on the gold market is a huge multiple of what it was. At this point, there are few even casual investors who have not heard of gold as an investment and heard someone extol its virtues. If we take a look at just how much gold the ETFs hold, we can see the power of this popularity. A chart of the total number of ounces held by gold ETFs is shown below.
As can be seen, even as the price of gold has dropped over the past few months and year, the amount of gold held by ETFs has steadily risen to new records. At this point, ETFs hold 84.34 million ounces of gold. This means that ETFs hold more gold than any other entity in the world besides the European Union, the U.S., and Germany. Combining the large amount of gold held by ETFs with the fact that all of that buying by ETFs has still not been able to increase the price yields an alarming picture.
If and when investors decide to decrease allocation to gold and ETFs begin to distribute gold rather than accumulate it, the price of gold could drop by a large percentage. While precious metals bulls will argue that buyers will step in to buy gold perceiving "value," we believe this is folly. Gold is purely a psychological asset, and the fact that the main fundamental affecting gold has been incredibly bullish yet prices have not been able to rise is a sign that gold investors are no longer willing to chase prices higher and higher. Unfortunately, with gold's current spot price nearly $1,000 higher than its cost of production in some cases, there is no actual "value" of gold which makes it a bargain at its present price. The most that can be said is that gold presents a good value at its present price because there will be more money-printing in the future, but are there any investors at this point who do not realize that?
With global monetary policy at perhaps its most one-sided ever, investors from Europe to the UK to the U.S. to Japan all realize that their central banks will print money with zero remorse. With that in mind, they have decided to stop increasing their allocations to gold. Without increased allocations to precious metals, especially from institutional investors, prices cannot rise in the long-term.
We recommend selling gold at the price of $1,659 or better. Active traders could take short positions in anticipation of further declines.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short gold. 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.
Disclaimer: All information included herein is the opinion of the firm and should not be considered investment advice. Past performance is not necessarily indicative of future results.