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Paulo Santos, Think Finance (393 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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It's a basic tenet of speculative investing, said perfectly by Herbert Stein:

If something cannot go on forever, it will stop

Such is the fate of any speculative endeavor whose underlying cannot produce the cash flows to support whatever valuation it trades at. Any such situation is little more than a pyramid of buyers and sellers where the only way to have a return is to sell to the next fool willing to pay more. This makes for an unstable market which will, at some point, implode.

Crowded trades like Apple (AAPL) showed this in spades, and Apple can possibly have the cash flow to justify where it trades at. Now imagine what was bound to happen to gold (GLD) or silver (SLV), which produce no such cash flow.

For a while I've been warning that gold and silver were crowded. I did so both from the angle of the quantity of metal being bought by the major ETFs, as well as from the angle of trader positioning. Not only were these assets crowded, but they exhibited signs of bubblish behavior which had last been seen at the top of the previous bubble back in the early 80s.

Now disaster has struck. Among increases in margin requirements, gold and silver have plunged 10% and 14% in just the last two days, and stand 26% and 51% below their 10-year highs (using the ETF highs and present quotes). Once again inevitability stuck even in an environment of money printing which could hardly be more supportive for the metals' prices.

So what now?

Given the quick implosion, there's probably a short-term bottom approaching. But the problem remains the same. Any recovery will be met by the fact that these metals are essentially a speculative endeavor necessitating a pyramid of buyers to sustain mostly any level not much above production cost. A significant part of demand, especially for gold, is always speculative and has no physical use. Even the gold council agrees to this when they publish the sources of demand as we can see (Source: Gold Council, red ellipse highlight is mine):

(click to enlarge)

What this means is that there is still large room for reduced speculative demand, so there is still large room for reduced pricing. As such, a rebound in gold prices is most likely a selling opportunity.

Alternative

One might ask, in the present monetary madness regime if one is not going to protect himself by buying gold, what should one buy, then? This is a valid worry - wanting to protect assets from possible inflation coming from the loose money printing. Trying to keep purchasing power for one's wealth is trying to make sure that a given level of wealth will be enough to buy at least the same amount of goods in the future as it is able to purchase today.

A simple -- and better - way to do that would be to purchase shares of those goods' producers. So, as long as this monetary madness persists, I'd say that buying dips in the stock market is the correct way to protect from possible inflation. The point being that buying dips in the stock market will show itself to be superior to buying dips in the precious metals.

Conclusion

Gold and silver were demonstrably crowded trades where bubblish signs were also obvious. Now those trades are unwinding, but their speculative nature remains. This means that whilst rebounds might happen, they are probably selling opportunities. All the while, if protection is sought for wealth, such protection will more easily be found in buying equity on goods producers. This can be achieved by buying a broad-based index such as the S&P500 through the purchase of an index fund such as the SPDR S&P 500 (SPY).

In short, if you're going to buy dips to protect your wealth, do so in equity, not always-speculative precious metals.

Source: All Crowded, Speculative Trades Unwind At Some Point