Recently an article was published that reiterated Goldman Sachs' Jeff Currie's assertion that gold (GLD) is a "slam dunk sell." The author maintains that the gold price failed to respond as one would expect to both the ongoing government shutdown and the nomination of Janet Yellen as the next Federal Reserve chairman. This confirms his belief that gold is in a bear market.
In this article I rebuke this argument. I am not so much making a bullish case for gold (although I am bullish) as I am negating a bear case. However before I discuss the specifics I want to more generally expose the fallacy of the following investment argument that the author puts forth:
- Event E is bullish (or bearish) for asset class A.
- Event E transpires, but asset class A falls (or rises).
- Therefore asset class A is in a bear (or bull) market.
The fortitude of the author's assertion implies that he believes this argument structure to be an infallible truism. This is obviously not the case: we often see an asset spike on bullish news before the beginning of a bear market--secular or cyclical--as was the case with the price spike in gold after the U. S. debt downgrade in September, 2011.
Since it only takes one counter-example to refute this argument we have done the job; but it is useful to look at the author's mis-conceptions regarding the specific assertions he makes so we can better understand the two events in question in relation to the gold market.
The Government Shutdown
The author writes the following regarding the government shutdown:
The first event is the debt ceiling stalemate, and the threats to default on the US Debt. If the credibility of the US Government is thrown into question, gold should be the natural substitute. A default on the US Debt would validate all the claims and fears that the gold bugs have been making for years.
I think this is somewhat vague, but I take it to mean that gold is a natural substitute for the U. S. dollar and U. S. debt in the face of the U. S. government's lack of credibility regarding its fiscal policies.
While I agree with this point I don't think what we are seeing now should be construed as a reason to doubt that the government will pay its bills. A few services have been shut down but this hardly scratches the surface insofar as the government is still running its largest operations such as social security. The media frenzy surrounding the government shutdown has perhaps convinced some Americans to purchase some gold, but the large players who really move the gold market are not reacting to the hype. Momentum traders are still likely shorting gold and they will take their cues from price action, not headlines. Central banks, particularly those in developing economies, have been accumulating gold for years, and some of this accumulation is due to the aforementioned mistrust of the U. S. government: mistrust of the U. S. government's ability to repay its bills has been driving the gold market for years.
Ultimately I think that the government shutdown is a non-event for the gold market. If it were more severe (i.e., if major government services were halted) I think the chain of causality that the author perceives would be material to the gold market.
Janet Yellen's Nomination
Regarding Yellen's nomination the author writes:
The second event is that uber-dove Janet Yellen has been named as Ben Bernanke's replacement. The headline "Rejoice: the Yellen Fed will print money forever to create jobs," says it all and should have sent gold higher, but it didn't. Almost guaranteeing that the taper will be longer and more moderate than originally expected.
The idea that lower interest rates and easier money is bullish for the gold price is intuitive. But historically the causal link between the two doesn't happen as an intuitive sequence of events as the author believes that it should. I have already addressed this crucial point in another article. If we look at the gold bull market during the 1970s we can clearly see that gold prices moved up along with interest rates. Consider the following two charts. The first shows the Federal Reserve's benchmark rate from 1972 through 1979. The second shows the gold price during roughly the same period.
The direct correlation is stunning in the face of our intuition: if we assume that correlation equals causation then we could extrapolate that the nomination of a dovish Federal Reserve chairman is actually bearish for gold!
Of course a more sophisticated viewpoint is needed: in the 1960s the price of gold remained fixed at $35/ounce in the face of rising government spending and debt levels, as well as a rising money supply. The effect is akin to holding beach ball underwater. Once the gold price was allowed to float freely it rose to a more appropriate level despite a monetary policy that is bearish for gold.
If we apply the same logic, then the loose monetary policy of Ben Bernanke, and the anticipated loose(r) monetary policy of Janet Yellen are bullish for gold, but bullish price action may not be seen immediately.
The author has failed to make a convincing case for gold's bear market on the basis that the gold price failed to react in a certain way in the face of certain events. Not only is the argument flawed in its general form -- as just one counter-example can demonstrate -- but if we look at the specifics we find that the government shutdown isn't so material for the gold price, and a dovish monetary policy, while bullish for gold, will not necessarily lead to higher gold prices right away.