About two weeks ago we looked at several measures of gold sentiment. The cross currents were a bit confusing but the DSI stood out since it was at the highest level of bullishness ever for that indicator since its inception in 1987! My final opinion was to defer to the parabolic nature of price and stand aside for a correction.
The precious metal finally succumbed to selling pressure and fell along with the already weak equity markets. To be honest, I haven’t really given gold enough credit during its impressive bull run these past few years. I’m wary of becoming a starry eyed gold bug so I prefer to rent it just like any other trade. I’m too quick to see a parabolic blow off but not objective enough to recognize the irrepressible power of a secular bull market in full swing.
This chart from Brett Arends went a long way to change the way I think about the whole question of a “gold bubble”:
Source: WSJ’s ROI Blog
If we assume that gold will have a similar run up - and why not? - then a target of about $3000 seems reasonable, give or take a few hundred per ounce. But what could possibly propel gold that high?
I know, I know, the usual list of suspects: Greece and the Eurozone’s sovereign debt implosion, the US dollar’s weakness due to a massive amount of debt relative to GDP, the injection of massive amounts of fiat money that will inevitably stoke an inflationary inferno, China’s imminent collapse, etc. The script is well worn by now and I don’t buy it.
When everybody knows something, it isn’t worth knowing. And when everybody is convinced of something, it is worth even less. Jeremy Grantham’s reluctant purchase of gold holds a clue. As he quipped at the the CFA Institute, “I hate gold. It does not pay a dividend, it has no value, and you can’t work out what it should or shouldn’t be worth. It is the last refuge of the desperate.”
So, tongue firmly planted in cheek, he decided to kill the secular gold bull market by buying some. If you know Grantham, you will know that he is a cautious fellow. So his purchase is probably a very small amount. Especially compared to the asset class that he believes has the most value right now, timber. That’s right. Wood. How many infomercials have you seen about wood lately? How many talking heads and gurus on CNBC have you heard debating over the price movements of lumber? But I digress.
My visceral aversion to gold stems from the same logic as Grantham’s. Unlike the gold bugs, I don’t see gold as having any intrinsic value. Well, like any commodity it has a functional demand for its use in industrial production of electronics, etc. But I don’t feel any emotional pull towards gold as “real money”.
The only way it will go up is if buyers are more aggressive than sellers - just like any other commodity. As Arends explains in his most recent gold article, the price of gold is higher because people are accumulating it. There is no shortage of gold. In fact, for the past 8 years aggregate supply has exceeded demand by a healthy margin.
If there is a second wind that will take gold up to the $3000 level, the catalyst will be crossing the tipping point of a virtuous cycle. That is, price will go up enough to attract new people to buy in the hopes of selling it to the next sucker, I mean buyer, for a higher price. And so on until we have a bona fide bubble on our charts.
The difference between those types of buyers and Grantham is that he has the wisdom to know the game being played. Most participants are distracted by fear (hyper-inflation) or greed and lose sight of when to exit.
For now, it isn’t at all unreasonable to expect gold to keep doing what it has been doing. For starters, the bullish percent index that we looked at for the sector has receded from 77% to 42% as a result of the recent correction.
According to TrimTabs, investors reacted to the weakness in gold prices by reducing the inflow into the GLD ETF from $1-2 billion a week to just $300 million.
Another indication of gold sentiment is the premium discount on gold closed end funds such as the Central Fund of Canada (CEF). Like the other measures, this sentiment gauge has dropped swiftly after the recent weakness.
Here is a chart is from CEFconnect.com showing the gap between price and NAV (premium discount) for CEF going back a year:
In early May the premium to NAV reached a relative peak at +13.17% but then it fell to +6% when gold futures fell last week. The premium is now at its long term average, +8.13%. You can see the premium discount chart correspond to important inflection points such as the low in February and the high in November 2009.
The Sprott Physical Gold Trust (PHYS), a young upstart on the scene, did have a frothy +30% premium when gold was trading north of $1240 but thanks to the market timing of Sprott itself, it was doused with a $243 million follow up offering. Sprott by the way is a great market timer and it pays to do as they do, not what they say. The premium on PHYS is still at a worrying +13% above NAV but I think that’s because this fund attracts the most woolly gold bugs out there (the kind that wear double ply tinfoil hats).
I’ll give the last word to Richard Russell:
Gold is in a huge, long-term bull market. My experience with in-and-out trading in a primary bull market is that you tend to be ‘out’ just when you should be ‘in.’ The best method of dealing with a bull market is to ‘ride the bull’ the way rodeo bull-riders cling to their bulls — and stay on the bull as long as you can.