Doug Kass, the President of Seabreeze Partners, who previously called the stock market bottom in March of 2009, has now turned bullish on gold. He admits that the intrinsic value of gold is difficult to evaluate and previously expressed his negative view of the yellow metal, but his bearish outlook has recently changed. Kass began a position in the SPDR Gold Trust (GLD) to back up his contrarian viewpoint. He stated that he is building a position in GLD over the next few weeks and months.
Kass explained multiple reasons for his bullish stance on gold. I included his words in italics and added my commentary after each one.
Expectations for the price of gold are now low and diminished. Gold experienced a speculative blow-off top 18 months ago as the European debt crisis peaked, the threat of a U.S. default ceiling rose and coincident with the debt rating of U.S. being lowered.
Kass seems right on target on this reason as the current consensus for gold is largely negative. This provides the foundation for his contrarian viewpoint. With expectations so low for gold, the downside risk is low, and the upside potential is high.
A most unpopular asset class provides a contrarian's appeal. Weak price action since September 2011 has created an improved reward vs. risk. Below is a chart that follows the price of gold since 1970.
Here, Kass is using the gold price chart to reinforce his contrarian view. We see how the price has fallen significantly after the peak. The price is now sitting at a multi-year support level. This technical view shows that the price of gold is likely to bounce higher from the current support level.
Last month's gold selloff looks like a selling price and volume climax. That first day of the mid-April collapse was a near 5 standard deviation move lower (or every 4,700 years) on huge notional volume of $20 billion. On the following Monday, gold took an even greater beating. Over the two-day period, there was a 8 standard deviation event, which occurs statistically about every billion years.
Kass is pointing out that the recent sell-off in gold was a form of capitulation. The current level has likely hit a bottom. Although the price may move sideways for a while before moving higher, the risk of further downward movement has been significantly reduced in my opinion.
Negative sentiment extreme. The sharp price drop in gold has brought on a growing short position. With it lies the seeds for a potential short squeeze or perhaps some latent demand from short sellers.
The growing amount of short positions in gold places the SPDR Gold Trust and other gold funds at risk of a short-squeeze which could quickly cause the price to drive higher as the traders scramble to buy back their shares. I think there needs to be a catalyst to trigger a short-squeeze. These catalysts could include: a worse than expected U.S. monthly jobs report which will be reported on June 7; negative economic news from Europe, China, or even Japan; and a drop in the price of the U.S. dollar.
The growing consensus view of an acceleration in the rate of global economic growth may be too optimistic. As such, not only might the recent rise in real interest rates be nearly over (as it holds the seeds for detracting from growth) but it raises the prospects for more QE, lasting much longer than many market participants expect.
Investors might get too complacent with the improving economic figures being reported. If unexpected negative news arises, this could trigger the fear trade and cause the price of gold to rise. The price of gold has been rising since the end of 2008 until the 'fall' of 2011. The bearish action in gold since the 2011 peak could be in for a reversal if economic sentiment turns negative.
The U.S. dollar's recent strength might peter out. A higher U.S. dollar is typically seen as a gold negative. But the recent strength, reflecting a growing consensus of Fed tapering, might be short circuited if global growth moderates.
As the large quantitative easing program being implemented in the U.S. continues, the dollar is likely to reverse its recent climb and continue dropping in value. When the dollar falls, gold typically rises. Although the Fed recently hinted at stopping QE at some point, no tangible plan was implemented to change course. It is likely that the Fed is merely saying that it is willing to do whatever it takes to either stimulate the economy or keep inflation to a minimum. I think that the current QE program that is in place will remain in place through 2015.
More currency debasing lies ahead. The currencies of all the major countries, including ours, are under severe pressure because of massive government deficits. The more money that is pumped into these economies (the printing of money, basically), the less valuable the currencies become and more valuable gold is.
It is not just the United States that has a QE program in place. Europe has a significant QE program. Japan has recently implemented a massive $1.4 trillion QE program. The dollar, the euro, and the yen, are all likely to lose value as a result of this QE. The price of gold is likely to rise as these currencies lose value.
Inflation is gold's friend. The world's debt load cannot be paid back in constant dollars. Reflating (and inflation) seem inevitable (though inflation may lie out into the distant future) and is the natural outgrowth of monetary policy.
Prices of oil, gasoline, houses, durable goods, food, and even incomes etc. are likely to eventually rise as a result of the QE programs in place. Inflation will typically cause a rise in the price of gold. The yellow metal acts as a hedge against inflation. Demand for gold should rise during a period of rising inflation, thus increasing the price.
Tail risks remain. I don't subscribe to the notion that all economic tail risks have been eliminated nor that the shoulders of growth will be borne by monetary policy. Rather I view an upcoming "aha moment," in which it becomes recognized that easing is losing its impact as the Fed is pushing on a string. Again, QE might be with us for a lot longer than many anticipate.
Here, Kass is referring to the fact that there is a widespread belief that the QE monetary policy will continue to create economic growth. The tail risk refers to the idea that the returns from QE should fall into a normal distribution curve with a high probability of success. Kass thinks that the curve is skewed in this case, with a higher failure rate for QE to create the expected economic growth. I don't really agree with Kass on this point. My thoughts are that the current QE program will continue to get the economy going to the point that it can survive on its own. I think that as the economy continues to improve, that higher interest rates will be tolerated if the Fed needs to tighten.
Demand for physical gold is rising. It is interesting to note that when the price of gold had its two-day crash in mid-April, the price for physical delivery (gold coins, etc.) held better (the premium increased) than future prices.
The increased demand for physical gold could be an indicator that the paper gold trade will soon follow. This could indicate that a turning point is right around the corner for the price of gold.
Previously bullish brokerages have given up on gold. Credit Suisse (CS), JPMorgan (JPM) and Goldman Sachs (GS) have recently slashed their gold price projections. I view this surrender as consistent with a possible contrarian signal.
The large brokerages can sometimes stimulate a contrarian signal. One example of this happened in mid-2008 when someone from Goldman Sacs was predicting an oil price of $200, when the price was near $150. The contrarians were out in full force when that prediction surfaced. A similar thing could be happening as the brokerages' projections could be too pessimistic for gold. We might be at the point of maximum pessimism for gold. This could trigger the contrarian trade and lead to a short-squeeze, thus driving the gold price higher.
The recent sell-off in gold was likely a moment of capitulation. It appears that maximum pessimism is here for gold. I agree with Kass on most of his bullish cases for the price of gold, except for his 'tail risk' theory. Although the gold price might not begin rising next week, it does look like conditions are ripe for the bull case to return soon. Complacency is beginning to return to the stock market after the strong run-up this year. A correction in the stock market is due and could also change the sentiment for gold from bearish to bullish. I think that now is a good time to start a position in gold for the long-term. What do the readers think?