Why the Gold Sell-Off is Unlikely to Last

|
 |  Includes: GDX, GLD, IAU
by: Jason Hamlin

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
US Dollar Chart

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.