The Bull and Bear Sides of Gold 22 comments
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Poor Tim Geithner! When he asserted that China’s Dollar assets are safe, he drew laughter from an audience of Chinese students. As well, an American delegation to the Gulf reportedly drew a blank back in May when it tried to get more petro-dollar investment into the U.S.
As the USD continues to plunge and the price of gold heads for another test of the $1,000 level, I thought it is time to review the bull and bear case for gold. In this review, I consider the economic, technical, investor psychology and geopolitical viewpoints when making my assessment.
Inflation and inflationary expectations under control
I have written before that it is probably too early for commodities to boom. The price chart of the iShare Barclays TIPS Bond Fund (TIP) below gives an indication of inflationary expectations. The price of TIP tanked late last year but has recovered since. Nevertheless, inflationary expectations are elevated but nowhere near hyper-inflationary fear levels. (Remember James Carville’s comment about wanting to be reincarnated as the bond market – and that's because the bond market is usually right.)
click to enlarge
Another measure of inflation is the Dallas Fed’s trimmed mean PCE, which some analysts consider to be a better measure of core inflation than PCE ex-food and energy. Trimmed means PCE seems to be running ahead of PCE ex-food and energy on a consistent basis in virtually all time periods, indicating rising inflationary pressures. Nevertheless, the readings are not high by any standards and inflation appears to be under control – for now.
Investor sentiment is very bullish (contrarian bearish)
Investor sentiment surveys on gold show a high degree of bullishness, which is contrarian bearish. Mark Hulbert’s analysis also points to the same conclusion.
Longer term, however, the smart money is bullish. Some very successful investors, like Julian Robertson and John Paulson are either long the inflation bet or short the U.S. long bond (which is equivalent to a long inflation bet).
Technical indicators long-term bullish but appear overbought
When analyzing gold and commodities, historical price action can serve as a guide. Since gold has been fixed at $35 until the 1970s, we don’t have that much of a long-term history. So instead I looked at the Continuous Commodity Index, which is a continuation of the old equal weighted CRB Index before its re-balancing in 2005.
The chart below of the CCI is supportive of a long-term commodity bull as it shows two episodes of upside breakout and consolidation since 1956. The last episode ended with the blow-off which took gold to its old high of $850 in 1980. Even if commodities don’t blow-off to new highs in the current regime, which is doubtful in this environment of hyper fiscal and monetary stimulus, the potential upside from current levels to the old high is 48% for the CCI. This is indicative of the minimal upside objective in a renewed commodity bull market.
Zooming in more closely, we can look at how commodities behaved when the economy emerged from past recessions. There the picture is mixed. In 1974, the initial price action was biased to the upside, but highly volatile. It wasn’t until 1977 that commodities settled down into a steady and sustainable uptrend.
The 1982 recovery was the start of a dis-inflationary era. That episode was marked by a minor uptrend, breakout and plateau, before a steady decline.
The 1990 recession also occurred in a dis-inflationary period. That period was marked by a continuing commodity price decline, which didn’t bottom until 1992, two years after the end of the economic downturn.
The 2000-2 recession was punctuated by the 9/11 shock to the markets in 2001. Commodity prices began a steady uptrend shortly thereafter. That commodity price bottom occurred well ahead of the S&P 500 bottom in October 2002.
Looking at the Continuous Commodity Index today, the CCI made a bottom in December 2008 and began an uptrend. Short term, prices are near top of the channel and commodities appear to be short-term overbought.
Looking at the longer term chart, does it stage an upside breakout and blow-off to new highs? Or does it remain in a consolidation pattern?
We’ll have to watch and wait. Even if it stays in a sideways pattern, the potential upside to the top of the trading range is about 48% from current levels.
The geopolitical wildcard
So far, the economic dimension and investor psychology both seem to tilt bearish on gold. But I didn’t mention the geopolitical dimension. Gold responds to geopolitical tensions. Could a geopolitical premium be building itself into the gold price?
What about the risk of war or conflict? Fabius Maximus sarcastically commented:
The plan for victory in Afghanistan is simple and sure:
1. stabilizing the country by garrisoning the main routes, major cities, airbases and logistics sites;
2. relieving the Afghan government forces of garrison duties and pushing them into the countryside to battle the resistance;
3. providing logistic, air, artillery and intelligence support to the Afghan forces;
4. providing minimum interface between our occupation forces and the local populace;
5. accepting minimal casualties to our forces; and,
6. strengthening the Afghan forces, so once the resistance was defeated, our forces can be withdrawn.
Is this like the U.S./NATO strategy in Afghanistan? Whether it is or not, it was actually the Soviet strategy in the 1980s. Oops! We know how that turned out.
I also found some more pointed criticism of the Afghan campaign strategy from the Fabius Maximus blog here.
Could Afghanistan be the geopolitical wildcard?
Meanwhile, here is a post over at The Cunning Realist:
I had an interesting conversation with a native of Pakistan's NWFP recently. He's young, well-educated (partially in the U.S.), and a member of his country's establishment. This won't exactly be news to anyone who's been following the situation there, but he's extremely worried about the effect of U.S. military strikes in Pakistan. Pakistanis see these strikes as targeting not a small group of high level terrorist leaders, but the deep-rooted, increasingly popular Taliban movement itself. One result is growing sympathy for the Taliban among his peers: the young, tech-savvy, well-connected elite who should be -- and traditionally have been -- opposed to everything the Taliban stands for.
Pakistan is a nuclear armed country. Could Pakistan be the geopolitical wildcard?
Right now, there doesn’t seem to be much of a geopolitical premium built into the gold price. The U.S./NATO conduct in Central Asia could be a long-term concern and a source of risk to stability.
Investors can average in, but traders should tread carefully. What’s the bottom line? What should someone do?
Given my long term bullish tilt of on gold and commodities, my inner investor tells me to dollar-average into gold and gold-related positions, especially if I have no positions in gold right now. My inner trader, on the other hand, tells me that while there are long-term opportunities in gold, I would wait for a pullback before piling in.
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This article has 22 comments:
Looking at them today, all are solidly back up and the dollar is down a tad. I agree with Cam - the investor in me says to hold these, while the trader says to sell half and keep a tight rein on the remainder.
Tell me about it!
Exactly what piece of data convinced you of this? Was it near-zero interest rates (the lowest in history)? Or record money-supply and debt-creation (the highest in history)?
Yes, U.S. real estate will continue going down in value (as will real estate in several other grossly-oversupplied markets). Beyond that, the future is already carved in stone - and the tidal wave of inflation has become.
People who don't seek to protect themselves (as soon as possible) with a large, precious metals component in their portfolios are playing "Russian Roulette" with their financial security.
I still don't understand why people seem to believe that precious metals are the only inflation hedge. There's oil, steel, copper, corn, wheat, soy, etc. Even earnings of stocks should go up with inflation raising their share prices. Anything except cash should be an inflation hedge...
That's totally besides the point. The point is, gold and silver will preserve their purchasing power in the long term, REGARDLESS of how much they're worth in a given currency at any given point in time. After all, it is not gold (or silver) that goes up and down in value over time--it is the fiat currencies that keep losing value when judged against the monetary metals gold and silver. And I think the Asians know this as well as any informed person on Earth...
On Jun 04 05:58 PM Jeff Nielson wrote:
> It is simply nonsense to suggest that either inflation or inflationary
> expectations are "under control".
>
> Exactly what piece of data convinced you of this? Was it near-zero
> interest rates (the lowest in history)? Or record money-supply and
> debt-creation (the highest in history)?
>
> Yes, U.S. real estate will continue going down in value (as will
> real estate in several other grossly-oversupplied markets). Beyond
> that, the future is already carved in stone - and the tidal wave
> of inflation has become.
>
> People who don't seek to protect themselves (as soon as possible)
> with a large, precious metals component in their portfolios are playing
> "Russian Roulette" with their financial security.
I can't resist thinking you used this article to make a cheap political point about the war in Afghanistan. This was a weak article at best, and leftist political point-scoring does nothing to help it.
What he is saying is that if you are going to get a spike (in gold) it will most likely be from a geopolitical situation.
Most people (on here particularly) think gold goes up in a bear market and is protection against inflation AND deflation (again buffoons!).
No wonder you are called missing link. "sigh"
On Jun 05 12:02 AM Missing_Link wrote:
> What on earth does Afghanistan have to do with gold and commodities?
>
>
> I can't resist thinking you used this article to make a cheap political
> point about the war in Afghanistan. This was a weak article at best,
> and leftist political point-scoring does nothing to help it.
Market crashed in 2008 - gold went up to $1000
Technically speaking, you're right, gold won't go up exponentially during a bear market, but it does tend to rally in the opposite direction to the stock market.
In 1974/1975 the inflation rate jumped to over 10% - price of gold doubled
Circa 1980 the inflation rate went up to 15% - price of gold tripled
What part of hedging gold against inflation don't you understand?
On Jun 05 03:58 AM maxe wrote:
> Thats when gold last peaked in the 80,s at the high 800's you buffoon,
> when the Soviets invaded....AFGHANISTAN.
>
> What he is saying is that if you are going to get a spike (in gold)
> it will most likely be from a geopolitical situation.
>
> Most people (on here particularly) think gold goes up in a bear market
> and is protection against inflation AND deflation (again buffoons!).
>
>
> No wonder you are called missing link. "sigh"
Market crashed in 2008 - gold went up to $1000"
Well you just seconded my point, you have no clue what your taking about, you forgot to mention when the market went down it (gold) went down to 600's and "technically im correct" except for 3 years or so? One period ( which i am referring to ) which was the AFGHANISTAN incident! Look if you dont understand the article google "soviet invasion of afghanistan".............
On Jun 05 05:43 AM rick12345 wrote:
> Market crashed in 2007 - gold went up to $1000
> Market crashed in 2008 - gold went up to $1000
>
> Technically speaking, you're right, gold won't go up exponentially
> during a bear market, but it does tend to rally in the opposite direction
> to the stock market.
>
> In 1974/1975 the inflation rate jumped to over 10% - price of gold
> doubled
> Circa 1980 the inflation rate went up to 15% - price of gold tripled
>
>
> What part of hedging gold against inflation don't you understand?
>
On Jun 04 06:07 PM Sheik Rattle Enroll wrote:
> I think $750 oz. is a reasonable price for gold, not one that will
> get you rich, but a good non-bubble fair price. At $500 I'd load
> up. At current valuations? Questionable. Oil seems to be at a reasonable
> price right now but not a load up price either. At $35/brl I was
> buying all I could.
>
> I still don't understand why people seem to believe that precious
> metals are the only inflation hedge. There's oil, steel, copper,
> corn, wheat, soy, etc. Even earnings of stocks should go up with
> inflation raising their share prices. Anything except cash should
> be an inflation hedge...
Cam: Shame on you. James Carvelle??? C'mon. He's a hater, you know that. POLITICAL HATERS ARE THE SCOURGE OF THE WORLD! This is not a political forum.
The haters (on this website) are reserved for gold (and silver) bugs. They are harmless, really. At least they won't try to run/ruin your life!
People thought oil would never hit $35/brl when it was at $180. The key is patience and not panicking and buying something just because its going up. There's such a thing as fair value. Look at the cost of a home in gold from 1940 to now. Gold is overvalued in relation to almost every other commodity and asset in terms of historical purchasing power. Sound like a good time to buy? Maybe if you plan on gauging the bubble and selling within a year, but I'm sure a lot of people had that plan in the 70s too.
Gold prices move are like a derivative of the inflation curve. Inflation going up 10%? Time for gold prices to not go up 10%, but to triple! Massive inflation is already priced in for gold, so what's left, pricing in hyperinflation on the order of hundreds of percent? If you believe that then you're better off buying guns and a grain mill.
Ever hear Ron Paul's an ounce of gold is worth a suit, always has been, always will be speech? I get custom made suits for $500. Suddenly gold should magically hit what, $2,000? $4,000? Then it's worth 8x its historical value.
On Jun 05 08:59 AM Rhett wrote:
> Yeah, I'll load up too when gold is $500. Pure nonsense.
>
> On Jun 04 06:07 PM Sheik Rattle Enroll wrote:
I would suggest that you take an advanced course in economics to gain a better understanding of why gold rose to the levels it did in 1980, and subsequently why gold will eventually catapult well over $1000 an ounce once inflation begins to rise.
A little history lesson for you. In 1921, faced with reparation costs of 132 billion resulting from the first world war, Germany decided to repay their debt by simply printing the money instead of using responsible fiscal policy. The consequent effect by 1923 was an inflation level of 1 300 000 000 000% , a direct result of imprudent expansion in the money supply. I wonder what effect Mr Bernanke's $12 trillion will have on the inflation rate, and subsequently, the gold price. Then again, I suppose the government will try to mask the problem by blaming some tiny war torn enclave in Afghanistan, and the ignorant masses once again, will believe devour it.
On Jun 05 07:05 AM maxe wrote:
> "Market crashed in 2007 - gold went up to $1000
> Market crashed in 2008 - gold went up to $1000"
>
> Well you just seconded my point, you have no clue what your taking
> about, you forgot to mention when the market went down it (gold)
> went down to 600's and "technically im correct" except for 3 years
> or so? One period ( which i am referring to ) which was the AFGHANISTAN
> incident! Look if you dont understand the article google "soviet
> invasion of afghanistan".............