Does gold’s recent tumble mean its spectacular run is at an end?
Gold’s proponents have trumpeted the fact that gold is a store of value in an environment where central banks are excessively trigger-happy in the printing of fiat currencies. However, in the wake of recent movements gold has begun to act as a sinkhole of value rather than a store of it. After peaking at roughly $1900 in late-summer, gold has taken a tumble, and after a tumultuous amount of activity over the past several months, gold currently sits near $1600, 16% off of its peak. The bears have appeared in full force, and even Dennis Gartman has declared that we are seeing “the beginnings of a real bear market, and the death of a bull.”
Hawkishness from the ECB and Fed
Some of gold’s recent decline can be attributed to the messages coming out of the Federal Reserve and ECB that further quantitative easing may not be as forthcoming as some had thought. Goldbugs would take any sign of quantitative easing, or “further debasement of fiat currencies,” as a bullish sign for gold. However, the Federal Reserve offered little hope of further QE in its latest statement, sticking with language very similar to that of the previous statement. Also, with recent U.S. economic data looking at the very least not terrible, the case for further aggressive action has somewhat diminished.
Mario Draghi of the ECB was even more unhelpful to goldbugs in a Financial Times interview on December 9 where he characterized the ECB’s recent bond buying as temporary and only to meant to address the dysfunctionality of monetary policy transmission channels. Also, Draghi contrasted the ECB’s price stability mandate with the mandate of other global central banks which have engaged in quantitative easing. These types of statements have made the prospect of the ECB engaging in quantitative easing under current circumstances more unlikely.
Gold’s recent drop seems to be congruent with the recent underperformance of gold equities whose valuation depends on gold’s price in the long-term (i.e. when gold is actually taken out of the ground). As of late many have claimed the operational issues at many miners and a spate of risk aversion in the equity markets have led to the delevering of the price of gold mining stocks to the price of gold. This can be seen in the steady decline in the Price-to-Net-Asset-Value of the miners, a decline that would be even more drastic if these miners were being valued at today’s gold spot price instead of a lower value (this particular graph uses NAVs based on $1,400 gold). However, one could also look at this anomaly as a sign from the market that these depressed valuations are a result of an expectation that gold prices are to come down.
The Slower Fool
The main risk to gold as of right now is a rush for the exits from gold investors eager to avoid being the slower fool (a variant of the greater fool theory). This theory stipulates that at times investors will buy an asset for more than they think it is worth in hopes of being quick in selling it to someone else for a higher price once the impending crash in its value arrives.
One of the downsides of gold is that it has no tangible value. It does not pay any dividends, and is only worth as much as what the next person is willing to pay for it. The sudden price drops gold has undergone can be seen in support of the theory that many gold investors are playing the slower fool game. It is possible that many of those who hold physical gold, or gold futures, or GLD, do not believe gold to be worth as much as it is trading, and are aggressively selling during market routs in fear of being the slowest fool in the market. If such a scenario is playing out then it is likely all of gold’s purported benefits will matter little in the face of an impending “discontinuous leap for investors” as the theory goes, and the ambitious gold price forecasts of the past year could very well be looked upon as similar to the calls made for Dow 36,000.
An Uncertain Path Forward
Given the gut-wrenching moves of the past few days, and the backdrop of a stunning rally in gold over the past several years, it may be wise to wait a few days until gold finds a trading range before putting on any positions. In my opinion, given the recent sharp sell-off, and the upcoming light-volume that accompanies the Christmas break, we could see bargain-hunting support for gold in the coming weeks, before gold finds its direction in the New Year. I would suggest buying December 30 GLD $155 (~$1600 gold price) calls and selling $160 (~$1650 gold price) calls in order to express a view on gold popping back but staying put somewhere between $1600 and $1700. This structure minimizes the premium paid to $144 per contract. Such a trade would have an upside of $352 and a max downside of the premium paid (based off of December 14 end-of day mid-prices). I would suggest waiting a few days for gold to consolidate before putting this on because it would make this structure even cheaper as these options’ implied volatility and time value decrease. Another way to play the market would be to short gold (GLD) against gold equities (XAU). This play would benefit if these miners began to trade more in line with the spot gold price, and represents less of a directional bet on gold if you are uncertain as to gold’s future direction.