Gold bears got some great news the other day, Fed Chairwomen has got their backs. Or so it seems. Her comments were a bit confusing, but the end results were undeniable and they weren't good for gold.
Since the beginning of the year, however, gold has been undergoing an exceptionally strong "dead cat" bounce and the goldbugs have been letting me have it. Finally they could point to a short period of time when I was finally wrong with my call on gold. Peter Schiff is back in the news calling once again for a golden moonshot. New comments are being made on my articles that are weeks old, and my inbox has messages letting me know just how wrong I am on gold.
Personally I didn't understand all the excitement about gold. Since the start of the year the market has had a decent correction, rates have fallen, many weak economic news reports were released, China had its first bankruptcy and Putin has been bullying the US, EU and Ukraine. Those combined to form a perfect storm for a sizable gold "dead cat" bounce, and that is just what we got.
Recently, however, the Chinese bankruptcy passed without much fanfare, the Ukrainian issue seems to have faded and Fed Chairwoman Janet Yellen came out swinging and gave gold a major beat down. The markets apparently thought she was going to be more of a dove than she was during the testimony.
Yellen Whacks the Gold Market, Too
Right or wrong, Wednesday's market reads Federal Reserve chief Janet Yellen as signaling a speedier path to higher interest rates.
So Gold traders are reacting to soaring Treasury bond yields by dumping investments tied to the metal and to the precious-metals sector.
Earlier, gold futures settled with the sharpest single-day drop in six weeks, with traders and market analysts highlighting factors from fewer worries over Ukraine to greater risk appetite in the market to, of course, this afternoon's news from the Fed.
"The market expects that the Fed will continue on its tapering program," Peter Hug, the global trading director of Kitco Metals Inc. in Montreal, said in a report. "The safe-haven bid seen in the gold market the past week or so has faded way."
That above quote validates the entire theory on gold that I've been outlining over the past year. As rates go higher, gold will go lower, it is that simple. The Seeking Alpha article that I wrote detailing the theory is actually stored on Duke University's Fugua School of Business' server, presumably as an article for students and professors to read and learn from. To be fair, the article quoted a Duke University professor, so it may be just to highlight the fact that a Duke University professor was mentioned in outside research.
Anyway, after a couple of months of sweating my short position in gold, I'm more confident than ever that the theory will pan out. As I outlined in another article, I expect gold to take out $770 before it takes out $2,000. In my opinion, gold is on the backside of a bubble, and is far from its ultimate bottom. Inflation won't develop until the late stages of this economic recovery, and I'm not even sure if a recovery has started. Bottom line, with Janet Yellen in the gold bear's corner, gold has just hit the canvas and it is just round #1 in the Janet vs. the goldbugs title fight. LLLLLLets get ready to RRRRRRRumble! My money's on Janet Yellen and the recovery.
Additionally, I would expect the Yellen beat down to impact other markets as well. One only needs to look back and see what got hurt last time the markets started to discount higher rates. Emerging markets (NYSEARCA:EEM), longer-term bonds (NYSEARCA:TLT), the Chinese and Russian markets should be hurt. Natural resource rich countries and their currencies like Australia and Canada should be hurt. I would also expect oil to fall if the previously mentioned economies falter, and drag other commodities like copper, iron, corn, wheat and soybeans down with it. The clear winner should be banks that will benefit from the steeper yield curve. Anytime you can borrow short at near 0% and then buy a government bond paying over 3% is a good deal. Additionally, the S&P 500 yield is about 2% which is close to many corporation's after tax cost of borrowing. Corporations may rush to borrow at low rates so that they can buy back shares at such affordable rates.
Gold bears don't only have Janet Yellen in their corner, behavioralist/sentiment tracker Mark Dow gave gold and Peter Schiff the beat down in this video. Key Points are:
1) There are no fundamentals behind gold, it is purely a sentiment driven trade. Fellow SA contributor Avi Gilburt will agree with that.
2) Peter Schiff thinks inflation will drive gold higher. He is, has and continues to be very wrong on that call. Inflation is not, nor has it been driving gold higher. Higher interest rates will drive gold lower proving my point.
3) Mark Dow review recent history and makes the point I've made nteenth thousand times, printing money does not (necessarily) cause inflation. I've said it, Mark has said it, it is consistent with recent history, Peter is simply wrong on a epic scale when it comes to his theory.
4) Listen carefully to the video, Peter Schiff states that "printing money is inflation." Peter Schiff and people that follow the neo-Austrian Schools of Economics follow a definition of inflation that is not applicable to financial analysis. The definition of inflation that matters to the markets and financial/economic analysis is the rate on inflation discounted in bonds. Peter simply refuses to accept the widely accepted definition of inflation, that being a sustained increase in aggregate prices. Peter can repeat his definition of inflation all he wants, but if printing money results in lower interest rates, higher bond prices and lower gold prices, his definition is worthless.
5) In the video Peter also makes the paranoid's claims that the CPI numbers are "doctored." He of course has no evidence of that, and the bond markets totally contradict that claim. Peter simply fails to understand the concept of inflation, especially as to how it relates to the markets and asset valuation.
6) Mark Dow makes the most important observation, "reality disagrees with you (Peter)." Peter simply sees the world the way he wants to see it, not how it really is. That is his fatal flaw, he simply isn't objective.
7) Peter is wrong, the US dollar will not collapse, it will rally with higher interest rates.
8) Food and energy are removed from the "core" inflation because their prices are highly volatile due to non-monetary factors. If OPEC cuts off supply or there is a draught, food and energy prices will increase due to a supply shock. Monetary policy has nothing to do with those price increases. Those kinds of price increase are irrelevant to the Fed's decision making. The Fed would be insane to increase interest rates because of a draught or oil embargo, it would be totally counterproductive. Peter simply refuses to accept that there are legitimate reasons for the Fed's actions and why the CPI is calculated the way it is.
9) Peter is wrong about the CPI understating the rate of inflation. It is widely known that the construction of the CPI has a bias towards overstating the rate of inflation. That fact is taught in every Intro Macro Econ class I've ever attended/taught.
This video validates my position that gold is nothing but a risk trade, and that higher rates will drive gold down. That comes from the floor of the CME.
Goldman Sachs is calling for gold to go to $1,050, and the video confirms the higher interest rates lower gold prices theory. There is a bit of a disagreement, but not much evidence was provided against the theory other than the 1980's and that was an inflationary period, totally different from today. More on Goldman's call can be found here.
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 also hold calls on GLL.