Why the Gold Sell-Off is Unlikely to Last

It must have really had the central bankers squirming in their seats to see gold break through resistance and head back towards $700. The HUI also shot through resistance at 360, and moved above 370 briefly. Tuesday’s pullback made some sense, as the dollar bounced off support at 80. But Thursday's $15 drop in gold, and 5% decline in the HUI index just plain stinks of manipulation.

This sell-off took place concurrently with a declining U.S. dollar and rising crude oil price, although crude later followed gold’s lead, and declined. The overall market decline could be contributing to the sell-off in mining shares, as the Dow fell nearly 3% on Thursday. The market is surely due for a serious correction, and may slip into recession before the end of 2007, as predicted by a host of investors including George Soros.

I can understand gold stocks being temporarily dragged down with the broader market, but all of the money that comes out of blue chip, and tech stocks will need a new home, and a portion of this will eventually move towards gold and energy. Not to mention that gold has historically been viewed as a safe-haven investment in times of economic uncertainty. And while America has been riding high due to the housing market, easy credit and a print-friendly Fed, the day of reckoning is fast approaching.

Bloomberg thinks gold’s sell-off is due to “concern U.S. subprime mortgage losses will deepen and reduce demand for commodities.”

Barrons said the dollar may climb over the next 12 months:

As usual, when the dollar breaks out, there is a chorus of predictions of an impending dollar collapse. We do not believe such a collapse will occur. Indeed, we agree with our official “house view” that looks for the dollar to modestly appreciate in the next 12 months.

I agree that the housing sector will worsen in the U.S., but commodity demand from China, and India should more than make up for the housing slump in America. And while this argument might make sense for base metals (silver to some degree), it does not really explain the recent sell-off in gold, which is used as a store of value, investment and jewelery, not for home construction.

The dollar may find some short-term support around 80, and even enjoy a small bounce, but it is only a matter of time before it breaks below 80. Barron’s idea that the dollar will climb, even modestly, over the next 12 months is far-fetched. It is more likely that the dollar will trade sideways for a short time, and then plunge.

We view these declines in gold as buying opportunities, and agree with the following commentaries:

Peter Grandich (Grandich Letter): “The capping of gold has led to stops being taken out, but it’s strictly a buying opportunity.”

Mark O’Byrne (Gold & Silver Investments, Inc): “Gold seems to have succumbed to a technically based sell-off as it may have become overbought in the short term. But there also may have been price-capping or manipulation by some of the larger institutional players.”

Ned Schmidt (Value View Gold Report): “The beginning of the demise of paper assets is unfolding before us. That selling is spilling over into the gold market. But the problem is with the debt delusion in paper assets, not with gold. This sympathy move is creating opportunities in the gold market.”

James Moore (The Bullion Desk): “Given that there remain large-scale issues with the U.S. mortgage and credit sector, investors may be increasingly likely to reduce their dollar exposure, which would prove favorable for gold longer term.”

Indeed, we are moving into India’s busy season for gold, when marriages and festivals increase demand for precious metals. And as you can see in the chart below, the dollar is hovering near a record low, with key support at 80. This support level is important for a number of technical and psychological reasons. If it is broken, a massive sell-off in dollars can be expected before any support is to be found. This is obviously very bullish for gold and silver, so we will be using these sell-offs in gold (manufactured as they may be) as buying opportunities.

click to enlarge

I recently came across a brilliant film entitled Zeitgeist. Of particular relevancy for gold bugs in the last part of the film, which deals with the creation of the Federal Reserve, the Internal Revenue Service, and the 1933 gold seizure, and the abolishing of the gold standard.

The bottom line is that the U.S. dollar is a fiat currency that is backed only by faith in the U.S. government. With public approval of Bush, and the U.S. Congress at 30% or lower, how long can this faith last? And how long will China continue buying massive amounts U.S. debt? The dollar has nowhere to go but down, and not only is it prudent to protect wealth by owning gold, but fortunes will be made by those who understand the information in this film and invest wisely.

Comments

[Jim Glazen:]

How long can the faith last in the US dollar? Longer than you can stay liquid.

Gold went higher because of rapid credit expansion and risk seeking psychology. As the opposite conditions take hold, I expect gold and just about every other asset to take a severe beating.

Enjoy!

2007 Jul 29 10:02 AM

[b0572:]

Jim,

You talk about Gold going higher in the U.S. due to credit expansion. Does this apply globally as well, because Gold is higher across all currencies over the last 5 years? Also, with the Sub-Prime meltdown, the Fed will have to ease to stave off a recession. The last fifteen years of U.S. growth (expansion) is based on higher debts levels in almost all sectors (Gov't. and Personnal the most). The last thing our government leaders want is a recession, just look at what the Fed did to interestest rates back in 2001. So, based on historical precedence, IMO I expect the Fed to ease and Gold to go up further.

2007 Jul 29 11:37 AM

[Jim Glazen:]

Money doesn't "come out of blue chip and tech stocks". For every buyer, there is a seller. Every dollar coming out of a stock is replaced by a dollar going into a stock.

Are you really so naive as to not understand a basic money flow?

2007 Jul 29 10:25 AM

[silverbullet:]

A person may buy one stock for $100 and you are right the person selling that stock receives $100. And a week later if that person who bought the stock wants to sell it at a loss for lets say $80, yes someone will buy that stock for $80 and you are right again. But there was an net outflow of $20 from that sector.

2007 Jul 31 10:35 AM

[Bob K.:]

Jim, regarding your second post, money moves into and out of stocks, asset classes, etc. continuously, (sector and asset rotation) and yes money does come out of a stock, that is why they go down in price. On Monday there was more money in the stock market than on Friday, where did the difference go?

Regarding your first post, price of gold does not move in price much on it own, it is essentially is the benchmark. It is the amount of dollars it takes to buy it that is the prime mover of its price. The price of gold in Euro's is much less than the price in dollars, yet the credit expansion is world wide. Those who believe the price of gold will rise see the dollars' continuous descent due to the rapid expansion of the dollar supply. I see this taking the U.S. into a recession and/or accelerated inflation which will force other nations to debase their currency to maintain a comparative trade advantage, this means all scarce commodities (Gold, Platinum, diamonds, etc.) will rise in comparison.

Instead of insulting these authors, regardless of your view of them or their motives, stick to laying out your case.
Bob

2007 Jul 29 11:47 AM

[Jim Glazen:]

Isn't it a simple concept to understand that a seller of stock requires a buyer? No money leaves or enters a stock on a net basis. For every trade, there is a buyer and a seller. If the price of a stock declines, it merely means its value has been reduced. That value reduction went to money heaven. A stock is not money. It's only worth what someone else is willing to pay.

I find it incredible that people believe a credit contraction and a recession is bullish for gold. Gold's chart over the past 4 years looks almost identical to small cap stocks.

We shall see what happens next. I believe commodities get crushed in the coming recession.

Enjoy!

2007 Jul 29 12:01 PM

[b0572:]

That's where you've got it wrong Jim. You believe there will be a credit contraction. Maybe in the short term you are right, but the rest of us are long term thinkers. These little short term contractions are the result of bad lending policy, not the overall monetary policy of the Fed. The following shortcut is from Doug Casey who I consider an authority on gold. This came from Kitco.com which IMO is one of the better web sites pertaining to precious metals. Just cut and paste into your browser. www.kitco.com/ind/Hunt...

It's not my intention to change you mind. I am just concerned that you're mis reading last weeks action. My best to you...

2007 Jul 29 08:43 PM

[Jim Glazen:]

wasn't doug casey bullish on gold from the early 80's top of $850 all the way down to $250 twenty years later?

case closed.

2007 Jul 29 09:26 PM

[GLS:]

Incorrect. Doug Casey got out of gold back in the mid-'90s and remained bearish for over 4 years. Those that did not heed his advise (me included) saw our holdings drop significantly.

2007 Sep 22 11:37 AM

[Joel Diamond:]

Amazing how cycles repeat themselves. You can easily have this same conversation regarding the state of the gold market today.

2008 Sep 15 11:00 PM