Mainstream Media Picking Up On Gold's Main Support Eroding

by: Robert Wagner

Executive summary:

  • Mainstream media is embracing the gold "fear" theory.
  • Classic gold relationships aren't driving gold.
  • Gold is likely experiencing another "dead cat bounce."
  • Gold selling prior to April 15th may trigger re-test of 1,200/oz level.


One of the first articles I wrote for Seeking Alpha was about how gold was being supported by fear, and not its classic driver inflation. I then did a follow-up to the article highlighting fear's weakening impact on gold. Today, that "fear trade theory" has gotten some major league backing. The Wall Street Journal, or WSJ, has an article out titled "A Word of Warning on Gold: Investor Fear May Be Fading." After all the relentless negative comments I've received over the past year, I welcome the WSJ joining the fight on my side.

In the article E.S Browning of the WSJ writes about many of the themes I've tried to cover over the past year. The main theme is gold being supported by fear or what is called "tail risk." He also likes taking on the sacred cows as I have done over the past year.

Gold is the stuff myths are made of.

Among the myths: It is a store of value, a hedge against inflation or a hard alternative currency.

Its behavior over recent decades suggests that it has been inconsistent in those roles. It has done better as something simpler: a bet on fear.

He also warns against the "dead cat bounce" nature of gold, as I have over the past year. In fact I wrote about it so often my articles started getting rejected and exiled to the netherworld of the Instablog.

Gold rose on basic economic fears in the 2000s but fell starting in 2011 as those fears abated. Now fears are spreading again about waning Federal Reserve stimulus and about global growth. Gold has rebounded 11% since mid-December.

Experienced gold analysts are warning clients to be careful: If the fears subside, the price of gold could do the same.

Senior analysts are well aware of this phenomenon, and are advising clients to sell gold into strength.

Sameer Samana, senior international strategist at brokerage firm Wells Fargo Advisors, suggests clients use gold's rebound to sell anything they have left.

"What we have found in our work is that a broad basket of commodities is a better hedge against inflation, a greater diversification and a better hedge against the dollar," Mr. Samana said.

Gold does well "when you are very nervous about the world," he said.

Sameer Samana also suggests a better alternative to gold as I have over the past year. Gold simply suffers by comparison.

He prefers copper, aluminum and zinc in a time of recovery.

Gold differs from other investments in an important way: It isn't very useful. Some is used for rings, watches, dental implants and electronic connectors. But the vast majority is hoarded as bars, coins or, in developing countries, heavy jewelry that serves more as a protection against disaster than an adornment.

Unlike stock, gold doesn't offer a stake in a business's results. It doesn't pay dividends or interest. It doesn't grow crops like farmland or provide shelter like a building. It is useful when people are fearful and flee to it.

Sameer and I are not alone, Morgan Stanley is advising its clients to sell into the rally as well.

  • Up 1.1% to $1,338 per ounce, gold takes out a new YTD high - with the GLD now ahead by 11% for 2014 - but the team at Morgan Stanley is a seller of the rally.
  • Calling the move an overdue bounce following five quarters of declines and heavy ETF outflows, Morgan says the metal is still held hostage by rising real interest rates and the strong greenback. The team also notes one conspicuous feature of the "bounce": Relatively low volume.
  • Morgan's forecast for gold is $1,160 this year and $1,138 in 2015, both below the estimated $1,200 marginal cost of production.

People hoping for gold to become an inflation hedge are simply looking in the wrong direction. Deflation is a far greater threat than inflation when unemployment as measured by U6 unemployment is near 13%. If inflation was truly a realistic fear gold would have sent an all time real high, not just a nominal high.

Particularly disappointing, gold has never come close to returning to its 1980 record once inflation is taken into account.

Gold futures hit a record $825.50 in New York on Jan. 21, 1980, which in today's dollars is $2,481.98. Gold's 2011 high was $1,950.15 in today's dollars, 27% short of a record. On Friday, gold futures closed at $1,323.90.

Stocks have hit inflation-adjusted records repeatedly since 1980, most recently in December and January. Gold hasn't. It is barely halfway back to its 1980 record, taking inflation into account.

Fear may be rising and justified in the Asian economies, but the US economy alone is 2x the size of China's and 3x the size of Japan's, so I doubt it will have the same punch as 2008 did, even if a crisis does happen. In fact China's central bank is a major holder of gold and may be forced to sell gold for US dollars in a crisis. Crisis selling of gold by the Chinese central bank in an effort to raise US dollars and weaken its currency relative to the US dollar would be a disaster for gold.

One reason for gold's recent rebound is demand in China and India, where economic worries have risen. Swiss refineries have worked overtime to recast big bars favored by Western banks into smaller ones preferred in Asia.

Lastly, the reason to sell gold is when there are better alternatives. As investors' risk tolerance increases, and they prefer returns over safety, the logical result is to sell gold and buy equities or other risky assets.

The Permanent Portfolio, a San Francisco mutual fund that invests in bonds, gold, stocks and foreign investments, ballooned to $17 billion a year ago from $57 million in 2000. Now it is back to $9 billion.

Michael Cuggino, its president, says gold wasn't the only reason for redemptions; investors have fled bonds and other conservative investments...Investors, he said, are more concerned about returns than protection.

The bottom line is that we've "been there done that with gold." Yes gold has had a nice rally since the start of the year, so what? Gold has had many dead cat bounces in the past and they have all failed post 2011. Nothing fundamentally has changed for gold since the start of the year, in fact the Fed's decision to continue with the "Taper" in the face of some weak economy numbers even makes the case for gold worse. Gold is currently running into long-term resistance, and I would imagine much of the low volume rally was simply shorts covering their positions, locking in gains and protecting themselves in case the trend-line is broken. If it does break the trend-line I would expect a sharp and short lived short covering rally, only for gold to roll over and re-test $1,200 again. One catalyst may be gold selling to pay the IRS for taxes due on April 15th.

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Disclosure: I am long GLL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own calls on GLL that extend beyond April 15th.