Gold's False Promise

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Includes: ABX, AUY, CDE, DUST, GDX, GDXJ, GFI, GG, GLD, GOLD, IAU, NEM, NUGT, SLV, SLW
by: Markos Kaminis

Summary

Gold found support recently as investors sought safe haven against energy price and U.S. equity market volatility.

However, I believe those seeing gold as a near-term safeguard against such volatility are mistaken.

That is because the root cause of the volatility should increasingly be European economic weakness, due to the costs of terrorism and the refugee crisis on Europe.

Such weakness has another repercussion, relative euro weakness versus the dollar, for as long as the U.S. is not directly threatened.

Relative dollar strength on domestic stability and growth I expect, a possible turn in China and a tightening Fed trajectory, against such euro softness, should drive gold down in dollars.

In recent days, media and markets have sought to depict gold as the premier safe haven destination for capital today. I continue to view gold as an important diversification tool and long-term alternative to the U.S. dollar. However, I do not see gold as a near-term safe haven. If I'm right, gold offers false promise to those believing it will safeguard them from near-term U.S. equity market volatility driven by oil price decline. The important reason why I don't trust gold is because of the probable cause of another energy decline, Europe. If the nascent pressures against Europe stymie the European economy, it would likely lead to oil price decline and U.S. equity market volatility, but at the same time, it would cause relative dollar strength. So those believing gold will protect them against this specific near-term risk are mistaken, because it threatens the euro and thereby serves the dollar, which in turn discounts gold prices for U.S. investors.

Spot Gold Day Chart at Kitco.com

Gold gained sharply Thursday, the result of a cascading impact of news from the European Central Bank (ECB) indicating it would likely stop lowering interest rates deeper into negative territory. The dollar index dipped intraday before stabilizing, energy prices declined, U.S. equities fell sharply and gold gained significantly. But the meeting minutes from the ECB offered information that was conveyed to us directly at the ECB's press conference in March, so the minutes revealed nothing new. Gold gained apparently on energy's impact to equities, since the dollar index was about unchanged at the time gold really took off. But there's a flaw here.

In a recent article, I suggested investors avoid European investment despite a contrarian's temptation to buy the beaten down region and what may appear to be value. My reasoning is because I am concerned that the refugee crisis and the costs of terrorism, and concern for more of it, will weigh further on European economic activity in 2016. I believe the expansionary efforts of the ECB may be rendered ineffective as a result, and European securities could retest lows.

Meanwhile, in America, labor data continues to reflect economic health. GDP expectations for the first quarter have come down with the most recent consumer spending data shortfall, but I view that decline as anomalous and the result of a negative feedback loop created by early year financial market weakness. I see the issue resolving itself in March and April, with better data to come.

If I am correct about Europe, where the 19 nation eurozone economy only grew 0.3% in Q4 2015, there could be contraction in Q1. The costs of terrorism are real; I know, because I'm a financial market survivor of the WTC attacks. We saw capital come out of the financial markets and an impact to GDP. The problem strikes in two manners, first in its impact to consumer spending, both from a decline in tourism and also in domestic consumption as people bunker down. Secondly, it impacts the operating costs of governments and businesses by raising security costs, but that comes with no positive impact to receipts or net sales, so the bottom line takes a hit. Europe is increasingly likely to see such a hit thanks to the two recent attacks in Paris and Brussels, and the risk of more. Now, European financial markets have already priced much of this risk in, but I expect not enough as data begins to show weakness even despite the extraordinary efforts of the ECB. And the costs of the refugee crisis compound the pressure on Europe.

The result of a setback to Europe's recovery is a negative impact to energy. There should be raised concerns about demand as a result of the issue, a topic I covered in my recent reiteration of warning against oil. The first reaction of U.S. equity markets to abrupt decline in oil prices is to sell-off. That is because of concern about the indebted energy sector and the financial institutions that have extended debt to the sector. It's also due to risk tied to energy centric regions of the country. And the initial inclination of investors in such a scenario is to consider safe havens, and one that naturally comes to mind is gold.

However, in this case, the root cause of the problem would be Europe, which would also have another important repercussion. The euro will shed value in such a scenario against relative strength in the dollar. This is especially true if China is rounding a corner, and if data continues to support Fed rate hikes this year; I see June as the next likely date for a hike. The dollar will appreciate in this scenario against relative weakness in the euro, especially if the ECB is forced to go another extra mile to stabilize the eurozone economy.

Precious Metal Securities

SPDR Gold Trust (NYSE: GLD)

iShares Gold Trust (NYSE: IAU)

iShares Silver Trust (NYSE: SLV)

Direxion Daily Gold Miners Bull 3X (NYSE: NUGT)

Direxion Daily Gold Miners Bearish 3X (NYSE: DUST)

Market Vectors Gold Miners (NYSE: GDX)

Market Vectors Junior Gold Miners (NYSE: GDXJ)

Goldcorp (NYSE: GG)

Newmont Mining (NYSE: NEM)

Randgold Resources (NASDAQ: GOLD)

Barrick Resources (NYSE: ABX)

Yamana Gold (NYSE: AUY)

Gold Fields Ltd. (NYSE: GFI)

Silver Wheaton (NYSE: SLW)

Coeur Mining (NYSE: CDE)

Click to enlarge

When the dollar appreciates, gold depreciates in dollar terms for U.S. investors, as do gold relative securities. And so these nascent gains in gold on the premise of short-term safe haven are misplaced. Gold will someday again provide such safe haven, when or if the United States and the U.S. dollar are threatened, but that should not be the case near-term, barring unforeseen unrelated event like significant terrorism in America. Thus, I suggest investors continue to avoid gold securities near-term, as I anticipate the precious metal should shed significant value under my anticipated scenario.

I cover gold closely, am unbiased, and provide honest analysis and opinion, often along with stakes long or short securities depending on my view. Because I see long-term value in holding physical gold, I always maintain a stake in the less liquid physical asset, while seeking to enhance performance with long or short stakes in securities. Relative investors who value an independent opinion are welcome to follow my financial column here at Seeking Alpha.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.