The International Gold Rush: Bulls May Soon Be Rewarded

In a week marked by a furthered short-term collapse of oil and a stronger U.S. dollar, the gold market saw prices drop off by $40 to settle near $925 an ounce. Investors seem quick to point the finger at the commodities market, using any sign of weakness as a cause for a stock market rally, but is the gold rush of late actually winding down?

It’s been a roller coaster ride by all means in the U.S. economy over the first two quarters. With the stock market sent into bear market territory, precious metals like gold and silver have soared to new highs before experiencing a recent correction ranging from 10% to 20%. Since hitting an intraday high at $1,033 an ounce on March 17th after a horrific Bear Stearns bailout, things have been range-bound in the gold market as prices have drifted in the mid-$800 to mid-$900 levels. I believe this trend is bound to break to the upside very soon, and I want to be invested when that inevitably happens.

The Case for Skeptics

Analysts point to gold as a market that has been over-heated by inflationary fears. Gold is a typical safety net during hard economic times, as it is commonly used as an alternative currency. Gold’s implied volatility currently sits around 36 according to Rob Kurzatkowski, futures analyst with optionsXpress in Chicago. This is significant because historical averages are pinned closer to the low 20s.

On top of near-term volatility and concern over a quick price appreciation, many point the finger at falling demand for the commodity itself. An estimated two-thirds of gold’s overall demand stems from jewelry fabrication, the demand for which dropped over 50% in the first half of 2008. However, despite this falling demand prices managed a 15% incline in the commodity over that same time-span. What this means to investors is that all “real” demand is being entirely ignored by traders in favor of investment demand.

Three Reasons Why Gold Moves Higher

Despite volatility that can cause short-term fear (such as that found in recent weeks), there are several reasons why the momentum points to higher prices in gold. I am concluding that we can all but ignore the typical “real world” supply-demand equation in favor of investment demand. The major catalysts I see for gold’s uptrend include:

1. Bullish trends in the gold options markets
2. The historical “gold-oil ratio” averages
3. Potential market-moving events to drive demand

Gold Options: As recently as Friday, July 25, options trading action pointed to levels upwards of $1,200 in the gold market. Bullion definitely has a chance to rally past these record-breaking levels, as a flurry of bets from out-of-the-money calls has a targeted range all the way up to $1,500 per ounce. After a recent fall in the commodity market, there has been strong volume on December $1,000 calls and spreads between $1,200 and $1,300. As gold options are currently dirt-cheap for traders, the trend in the options markets has higher gains on the radar.

Gold-Oil Ratio: One of the more interesting data points is the historical average gold-oil ratio which is at this point in time completely off the mark. If history proves an effective lesson, precious metals need to increase dramatically while oil needs to continue its decline. As we are sitting right now, gold would need to hit the $2,000 per ounce mark in order for the ratio to balance. Granted, this can be offset slightly with oil tailing off further; but the case for rising precious metals is evident.

World Events: Certain market moving world events could lead to a staggering demand for gold, adding yet another catalyst to the bullish playbook. With the possibility of domestic & international economic disaster, a strong threat of inflation around the world, the potential catastrophic war between Israel & Iran and even flailing currency markets, any one of these deal-breaker events could cause a sharp jerk upwards in the gold markets. Investors betting on the world’s furthered economic demise are moving all the chips on the table toward the precious metals markets.

Playing the Gold Trend with Stocks

While it takes a seasoned investor to place bets on actual commodity trades, there are many ways for individuals to capture the growth by investing in alternative stocks such as precious metal miners. I have owned Yamana Gold (AUY) [12.30, 0.00 (0.00%)] several times in the past, and continue to pump-and-dump the trade for profits. I have never suffered a loss trading the company, and look to enter in soon now that we have reached sub-$13 per share levels on AUY. My two other favorites in the gold market are much larger in size with hands in other precious metal markets. These names are Barrick Gold (ABX) [42.58, 0.00 (0.00%)] and GoldCorp (GG) [39.60, 0.00 (0.00%)].

As much as I enjoy speculating on the future growth in gold with names like Yamana, Barrick & GoldCorp, those that appreciate long-term success may wish to have a look at Freeport-McMoRan  (FCX) [95.63, 0.00 (0.00%)], a leading purveyor of gold and copper that seems to hold much steadier in long term patterns. FCX is a great hedge in any portfolio, and can add a fresh look of diversification if you don’t mind marginally lowering your upside to balance risk.

Predictions & Opinion

In my mind, there is absolutely no reason that gold should still be sitting below $1,000. I am calling for $1,150 an ounce by the first quarter of 2009. With commodity levels headed back toward $900, I feel that a rebound in precious metal markets is imminent despite the occasional bear market rally on flailing oil prices. If you can stand the volatile short-term movements in the market, gold bulls may soon be rewarded.

Disclaimer: The mutual fund that the author is associated with is long FCX

Comments

[bold4gold]

I agree 100% with your "Opinion and Prediction" section. I think there will be a lot of money to be made between about mid August and the end of the year.

[vaduz]

kinross is another good bet and maybe newmont mining

[bowman711]

If Congress passing (and the President saying he will sign) what some say is the biggest (deficit) spending package since the New Deal moves gold down, what on earth will it take to make it move up? A nuclear bomb over some U.S. city?

I don't think you can blame such contra-economic behavior on gold's 'summer doldrums.'

[CLH]

Gold made a double top after an eight year run. Its down down.

[salp]

GSPG! GO GOLDSPRING.

[drbagel]

fiddle,Nero, fiddle

[BrunoT]

CLH, way to see the macroeconomic picture and back up your opinion with reasoning. Double top? Oh yes, it MUST go down then!
Is that what the tarot cards tell you or something?

Let's see. $500B deficit projected BEFORE the mortgage and other bailouts were counted in. A recession in the works that will cause tax receipts to fall further, increasing the money printing. REAL rates of return on CDs/MM's that are way negative. War with Iran looming. Few stocks looking at anything positive for a year horizon. Gold at about 35% of its inflation adjusted high (which occured during similar economic conditions to today's)

Yeah, what a great time to sell your gold....not.

[LarryH]

They may be rewarded, and they may not. Jim, you do not build a strong base on the fundamentals from which to come to your conclusion. I hold gold and silver as well, but I am afraid your call just doesn't come from a logical assessment of the fundamentals, and your opinion, as mine, plus a buck might get us a cup of coffee.

[FoxV]

"Gold made a double top after an eight year run. Its down down."

hindsight is always wonderfull but completely useless, and in the case of gold, completely wrong.

Can't vouch for the last 8 years, but in the last 6 years gold has made 6 double tops. Each of them similar in magnitude and structure to this one.

The US dollar index however made a double top in 2001 and has been a train wreck ever since. I don't see it turning around anytime soon while Ben is at the helm.

Best predictor of Future behavior is past behavior

[[e-mail]]

I'm putting my money on GSPG

[sandspider]

Yes BrunoT, I have to agree plus add a few other figures that drive the market as well. The official CPI is humm around 4.5% but prior to 1980, when we add in things like food and fuel and taxes we have a nice 11.5% CPI. Changes so they didn't have to up the Social insecurity system payouts. And lets look at the unemployment figures. U-3 a nice 5.5% they tell us. Well they are keeping book on U-6 which they don't publish which is 9.7% and now lets add in for all those poor folk who are no longer counted at all....those out of work for over a year and whoooo you get 13.7% The GDP is negative not positive if you take into account all those lost figures. Consumer confidence down from 105.3 to 50.4 the lowest in 16 years. Smoke and mirrors. Oh me oh my. And then on top of all that good news the Gulf Cooperation Council (Saudi, Kuwait, Bahrain, Omar, Qatar and the UAE) are looking at starting their own currancy. Watch out Euro. What $$$??? And sooner or later someone is going to pull another trigger (Iran, Africa, Israel....) and the good ole USA is going to go for broke. Some one smell something burning? Rome? The Fed? See you in September as the song goes.

[User 30121]

Very nice piece, Jim. Thanks.

When I was reading, I just KNEW that CLH and his narrow-minded, backward-looking cronies would pitch a fit! They CANNOT understand the inner workings of gold (and silver). Many of you that posted DO know those workings. I'm buying gold and silver, taking POSSESSION, and I'm just waiting.....to smile!

[Jim Regan]

Thanks for the kind words guys, please support my new blog (and the original post) here: www.bullishbankers.com.../

Gold's almost down to the $900 level at this point, I'd be a big bull as soon as it touches

[Ops did itagain]

LarryH says: ..plus a buck might get us a cup of coffee.

What I really want to know is where do you get coffee for a buck?

[marxbites]

Just watch Edward Griffin's video on youtube;

"The Creature From Jekyll Island; Revisiting the Federal Reserve"

Then if that snks in go to mises.org for even more in depth history and economics from the Austrains that foretold the fiat enabled rise of the Euro-statists our progressive era policies & Fed were modled after!

What a country of sheeple being merrily led to their own slaughter.

Thing is I was baaaaaing not too long ago myself, before getting myself the education govt purposely denied me and all Americans.

[marxbites]

You can blame gold's being sold down by paper trading of the Central banks who least want us to understand just how bad a shape the worldwide fiat currencies are.

Dig: In 1932 $1 = 1/20th oz gold

Today $1 = 1/1000th oz gold

A 20:1 ratio has become a 50:1 ratio, ergo a $1 buys 1/50th of what it could in 1932.

1/50th = 0.02 = $0.02 cents/$1 of buying power today.

Do you think the FED will keep printing as do most of the saavy, or will it call in dollars from all over the world to raise the $1's purchasing power?

History proves the ratchet is always the former, IE the FED has stolen 98% of the people's wealth via inflation thus far.

Only saps can think it will change it's shylock thieving ways.

The Ben & Hank show is just in it's beginning scenes.

Per the Maestro himself:

Alan Greenspan - “Gold and Economic Freedom” 1967

"An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense – perhaps more clearly and subtly than many consistent defenders of laissez-faire – that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. . . . This is the shabby secret of the welfare/(warfare) statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights."

The PEOPLE'S property that is.