Gold's Devilish Advocate

By Brad Zigler

In certain circles I'm known as a curmudgeon. Yeah, that's right. Crusty, irascible and cantankerous. Hard to believe, isn't it?

The funny thing is that people on both sides of the hard assets spectrum share that point of view. To so-called gold bugs, my under-exuberance for wildly optimist gold forecasts is anathema. Monetarists, on the other hand, grouse about my metering of the dollar's value against bullion.

No matter what side you line up on, you can't have ignored the $300 rally in gold prices since late October. For the February COMEX contract, that amounts to a 46% increase; pretty much a replay of the run-up that ended last March. That should prompt you to wonder about the odds of gold topping out again.

No doubt, the answer to that depends upon your gold Weltanschauung. But let's play devil's advocate for the moment. What factors argue for a gold sell-off? Or, at least, for keeping a lid on the metal's ascendance?

The Dollar/Gold Dyad

This year, the dollar's provided as much refuge for worried investors as gold. Ordinarily, there's an inverse relationship between gold and the dollar. In the current global disinflationary environment, though, the greenback is proving to be the best nonmetallic haven for global capital. Rising dollar interest rates will enhance the buck's attractiveness. At least until a cyclical reflation of the currency. Yes, there will be a lot of dollars out there. But right now, there are a lot of representations of the dollar-bills, notes and bonds-awaiting redemption.

The dollar's prior inflationary pace was braked well before the price of gold peaked last March. We've yet to see the leading edge of reflation.

U.S. Monetary Inflation And Gold

Dollar interest rates bottomed just before the Obama inauguration and have steadily gained ground since then. Rising rates are like lipstick: A judicious dose can enhance the beauty of a currency; too much, and it looks tawdry. There's nothing tawdry, though, about the 18-point rise in the dollar LIBOR over the last month. It's sustainable and makes the buck even more attractive.

Dollar Interest And Gold Lease Rates

Gold Liquidity

The gold lease market belies the shortage scenario played up by many market pundits. Gold lease rates have been falling precipitously as the contango reflected in forward rates has been rising. Contango exists when supplies are plentiful. The current oil market provides testimony of that. The gold market - at least the commercial gold market - gives every indication of being well-supplied.

Overbought Market

Relative strength in gold futures crossed into overbought territory when the spot contract topped $1,000 last week. The peak, if not exceeded, would represent an interim double top and confirmation that the March 2008 high is likely to hold.

COMEX Futures Open Interest

Speculative Aggressiveness

Commercial hedgers are still driving gold futures pricing. Aggressiveness on the part of large speculative buyers has actually waned as prices moved higher. Over the past month, net long speculative positions rose 34% while commercial net shorts picked up 40%.

Essential Question

Think back to the events surrounding gold's March 2008 peak and ask yourself this: "Have economic conditions improved or worsened since then?" I think it's fair to say our financial troubles have deepened. If that's true, and if gold is a safe haven, why hasn't the metal made new highs?

This is by no means an exhaustive analysis, but it does raise essential questions that gold bulls should be prepared to address when making their case for higher prices.

Don't expect to hear the answers in the late-night infomercials hawking gold, though.

Comments

[Alex Filonov:]

Couple more data points:

1. NYMEX open interest for April exceeds open interest for all other months. ETF effect?

2. India is not importing gold anymore. Regular buyer of 30% physical gold is out of the market.

Feb 27 10:31 AM

[jschulmansr:]

Brad; Pontificating aside, where do you stand in relation to Gold? Both short term and long term? No charts or arguments just a simple statement I believe Gold will...

Thanks!

Jeff Schulman Sr aka jschulmansr

Feb 27 11:13 AM

[Brad Zigler:]

No one, of course, "knows" gold will drop or rise from any particular price level. T

here are, however, technical indicators such as the Relative Strength Index and stochastics which identify certain market levels as overbought or oversold.

A double top is a price level reached a couple of times by a market as it attempts to rally higher but can't be hurdled. The failure sets up a decline.

About gold leases. Often, nefarious intente is ascribed to central bank swap activity. But leasing can be simply a way to garner a return on an otherwise sterile asset as well as a way to stimulate lending and investment activity.

Outright borrows of bullion by bank customers tend to increase when bearish sentiments prevail. In essence, the borrower doesn't want to face the prospect of buying back gold at a higher price to close out the loan.

With that in mind, the market may already favor shorts BEFORE leasing.

On Feb 27 09:25 AM craigdude wrote:

> Brad- could gold be controlled by governments leasing gold and selling
> to keep lid on prices?--please explain double top and overbought

Feb 27 11:20 AM

[jschulmansr:]

Brad;
Ps- I guess I should have added I think your articles are very well written and thought provoking. I make mention of and use your stuff on my blog quite often, but recently I have not heard your outlook for Gold. I do agree we are at a crossroads here, we may see more retracement. I think we are about to see Gold go and test it's all time highs. Failure there I think will mean a retracement potentially as low to $880 to $890. If we clear due to manipulaton and where the short interest got in at there will be sttrong pressure to bring down prices at the $1050 level. If that hurdle is cleared I think that the banks who are short will give up and cause a very violent spike upwards "shortcovering rally". After all they can afford to give in now as they figure they can get their money back thru Government stimulus, TARP, and bailout funds. Long term however, I do feel with inflation runnng a tad higher than what you are currently stating,and the fact that the monetary printing presses are running full steam round the clock; that longer term we will see inflation even hypr and/or stagfaltion. In other words get your wheelbarrow to haul your money around to go shopping for a "loaf" of bread. I truly think that prices of $2000 to $3500 oz are not unrealistic given the aforementioned scenario. What is your opinion in regards to this? Maybe even a special article?- Thanks Again- Jeff Schulman Sr aka jschulmansr

Feb 27 11:29 AM

[Brad Zigler:]

Don't read too much into the large open interest in April futures. There are certain delivery months for gold that are traditionally more active than others. April is one of them (February, June, August, October and December are the others).

As February's expiry approached, open interest rolled to the next active month in the cycle--April. Yes, some of that is ETF interest (namely, DBG, the PowerShares DB Gold ETF). It doesn't, however, include the SPDR Gold Shares (GLD) or the iShares COMEX Gold Trust (IAU). These trusts hold physical metal, not futures.


On Feb 27 10:31 AM Alex Filonov wrote:

> Couple more data points:
>
> 1. NYMEX open interest for April exceeds open interest for all other
> months. ETF effect?
>
> 2. India is not importing gold anymore. Regular buyer of 30% physical
> gold is out of the market.

Feb 27 11:31 AM

[@TexasER:]

Speculating on the price of gold has always been risky, never more so than now. If you’re in this trade to turn a quick profit, you have more guts or brains than me.

But as “melt-down” insurance, gold has performed exactly as advertised. I see no indication that it will somehow stop acting this way. If the markets fall off another cliff, obviously gold will do well.

Diversification has always been a prudent strategy. That hasn’t changed, but gold’s importance to a diversified portfolio has changed. Some investors have recognized this out of prudence, not panic, and acted accordingly.

I’m long, but if gold goes to $500 from here, you won’t hear me whining about it.

Feb 27 11:48 AM

[jschulmansr:]

Brad; Thanks for your answer, I am sure you are aware of GATA, that is really were one of my main concern lies. The continued manipulation of prices by both governmental and banks. It will be very interesting to see what the CFTC and Comex are going to do with their investigations in both the Silve and Gold markets. Also long term I think we have a couple of big plays coming up with Silver and Oil. That's what I love about the markets, sheer boredom puncuated by moments of either sheer elation or sheer terror! Thanks again! - Jeff Schulman Sr aka jschulmansr

Feb 27 12:03 PM

[Conan the B...:]

Devil's Advocate would mean your views are the opposite of what the Article implies.

My take on Physical Gold is very simplistic.

A Stock Market selloff usually occurs in Sept. Just In case another October Massacre occurs.

Gold does not have a lot of History preceeding it at the $1,000 level But we do know it started sliding in March of last year. A slide in February/early March is logical.

IMHO

Feb 27 03:28 PM

[Cesato:]

February/March seasonal demand in India has been very little, some say there has been no imports of Gold for the wedding season. We are very much to the mercy of big players. Beware of volatility and eventual sell-offs; even though the sentiment is very bullish towards Gold if there is a sell-off it won't be a stepped sell-off but a massive liquidation. Technically, February's monthly close does not look very pretty, USD 988 will have the final word for the quarter, March will give the final hint for 2Q.

Feb 27 06:42 PM

[silverwood:]

To call the top in gold at this point is premature. I know those forces opposed to gold would like to make everyone believe the top is in. Recent action in the market is suggesting that another assualt at making a new higher high is going to occur. What gold percieves is a hugh world financial crisis caused by fiat money, which is debt money. Central bankers have only recourse and that is to print money for governments to spend and continue the debt spiral deeper, as that is how this monetary system thrives. It is not a matter of if but when price inflation arrives, those not protected will understand what loss of purchasing power truly means.

Feb 28 12:14 AM

[Roger Knights:]

"Think back to the events surrounding gold's March 2008 peak and ask yourself this: 'Have economic conditions improved or worsened since then?' I think it's fair to say our financial troubles have deepened. If that's true, and if gold is a safe haven, why hasn't the metal made new highs?"

1. Some people back then thought the dominoes would all fall at once, after the first one fell, so they were in a panic and pushed the price to an extreme.

2. A lot of gold bugs and other speculators placed highly leveraged bets on the futures market, which multiplied their buying power and drove the price higher,

3. There was a fad for commodities in general early last year, which aided gold's rise.

4. The dollar was falling (I think), another pro-gold factor.

At present:

1. People think that the financial house of cards is not going to topple--the bubble won't pop, but undergo a managed deflation, which reduces the urgency of buying gold.

2. Now most gold bug buying is less leveraged, via an ETF or in "physical."

3. The commodities fad is over for the moment--and many investors see gold as a commodity, reducing the number of potential buyers.

4. The dollar is holding up, which gives people an alternative safe haven. And the fed has stated that it will support the price of its long bonds with direct purchases, making them less risky as another alternative safe haven. (So long as the dollar holds up.)

So those are the reasons why gold hasn't exceeded its old high. They are also reasons why it will.

Feb 28 12:44 AM

[aristid:]

Where is all the money coming from in the fundings of IMF, EIF, EIB etc?
Are they not supplyed with gold by the govs, supporting those funds? Therefore they are forced sellers at times, like Gold at 1000?

Feb 28 10:15 AM

[zepheri:]

In regard to gold being "no use what so ever other than a financial instru ment". Please, gold can be made into anything. Electronics love the soft yellow stuff. Much of the reason gold has a long history is because it is great to work with. Take a gold coin and with a hammer you could make a spoon, shot glass or a divot fixer. More recently the healthcare industry, solar, computer and battery making. The smaller devices get the higher quality conductors are needed. They use alloys to keep cost down but they need properties unique to gold and silver for that matter.

Feb 28 02:18 PM

[Mad Hedge F...:]

HJ il Panic buying of gold coins continues to overwhelm coins dealers around the world. According to the Financial Times, the US Mint sold 193,500 American eagles in the first seven weeks of this year, more than it sold in all of 2007 at prices 40% lower. Retail investors fleeing paper assets, like plummeting stocks and bonds, are paying 5% premiums over face values. The same phenomena is appearing in other countries were gold coins are available to the public. Does this have a toppy feel to it?

Feb 28 10:13 PM

[tb1975:]

The author writes:
"I think it's fair to say our financial troubles have deepened. If that's true, and if gold is a safe haven, why hasn't the metal made new highs?"

Ummmmmm...the US dollar index is 88 now versus 72 then (March '08). This probably has something to do with it.

Feb 28 11:50 PM

[keo:]

I agree with tb1975. I live in "euroland", so I look at gold in euro terms. The march 08 high was around 670, and recently gold touched almost 800 euro/oz. Gold made new highs in most currencies, except the usd (and pegs) and the yen... Imho, these two will crack sooner than later, unfortunately...

Mar 01 03:23 AM

[Andreas:]

The real value of Gold is not more than $150.00. Sooner or later all "Banks" will try get rid of their Gold holdings

Mar 01 02:37 PM

[Brad Zigler:]

Dollar gains are baked into the monetary inflation chart near the top of the article. An explanation of the methodology behind the computation can be found in the Hard Assets Investor article "Computing Inflation In Real Time" at www.hardassetsinvestor....


On Feb 28 11:50 PM tb1975 wrote:

> The author writes:
> "I think it's fair to say our financial troubles have deepened. If
> that's true, and if gold is a safe haven, why hasn't the metal made
> new highs?"
>
> Ummmmmm...the US dollar index is 88 now versus 72 then (March '08).
> This probably has something to do with it.

Mar 02 04:23 AM

[Brad Zigler:]

You can see the catch-up game played by the euro in the second chart accompanying the Hard Assets Investor article "Why's The Dollar So Strong?" at www.hardassetsinvestor....


On Mar 01 03:23 AM keo wrote:

> I agree with tb1975. I live in "euroland", so I look at gold in euro
> terms. The march 08 high was around 670, and recently gold touched
> almost 800 euro/oz. Gold made new highs in most currencies, except
> the usd (and pegs) and the yen... Imho, these two will crack sooner
> than later, unfortunately...

Mar 02 04:29 AM

[Brad Zigler:]

Near as I can figure, about $204 of gold's current dollar price can be attributed to monetary inflation since May 2006. This is based upon the methodology outlined in the Hard Assets Investor article "Computing Inflation In Real Time" at www.hardassetsinvestor....

What's the basis for your number?

On Mar 01 02:37 PM Andreas wrote:

> The real value of Gold is not more than $150.00. Sooner or later
> all "Banks" will try get rid of their Gold holdings

Mar 02 04:38 AM