Gold's Divergence Between the Paper and Physical Markets

As regular readers probably know, Kevin Depew of Minyanville was taken to task here the other day for parroting all the other talking heads on TV who apparently don't know enough about how commodity markets work that they jump to the conclusion that a 20 percent decline in price signals something of a major change in trend as it does for equity markets.

While I can't exactly say that I felt bad for having to point out that the price of crude oil has declined 20 percent or more in seven of the last nine years (or something like that), I can't exactly say that I felt good about it either.

As part of the healing process, I'd like to bring to readers' attention some truly excellent commentary by Kevin titled Panic Selling in Gold: What Next? that appeared Friday over at Minyanville (a big hat tip to anon who pointed this out in the comments section of the previous post).

As for gold, I would like to be more positive on the metal itself, but I believe this selling is related to a buildup of longer-term deflationary pressures in the credit markets that will dwarf the inflationary mask of (formerly surging) food and energy costs...

I most certainly believe gold will eventually be an asset to own in coming years. However, at the onset of deflation, gold will be sold indiscriminately - like all assets - to pay down debt and repair balance sheets.

The initial asset price inflation and central bank reflation efforts that made gold seem attractive during the building of the asset price bubble sow the seeds of the selloff as speculators attracted to the metal simply as a detached, non-fundamental momentum play will need to unwind their leveraged bets. Weak holders will be shaken out and ultimately replaced by those seeking a store of value. That is why the selloff won't make sense on a fundamental basis.

I show on the metal itself DeMark exhaustion sell signals on the long-term quarterly and monthly charts. But, the only people that should really be concerned about whether gold is going up or down right now - other than in the macro sense - are those very people who will likely need to sell and therefore be responsible for it overshooting on the downside. I expect in the next few years for gold to retrace part of its long-term move, perhaps coming below 600 and, in the worst case, possibly even coming below 500. A 50% retracement of this major bull move would be about 458. But that doesn't change the long-term, secular bull market for gold.

This is one of the best summaries that I've read in recent days for what's been happening in the gold and silver markets and it helps to explain the divergence between the physical market (store of value holders) versus the paper market (the momentum crowd).

Of course there are other theories to help explain this divergence.

As for central bank re-inflation, I think what we've seen over the last year is just a warm-up and that most people underestimate the will of governments and central banks to debase the currency on a scale never before seen in an attempt to get things back to "normal".

Recall that, in the U.S., our memories of the worst financial crisis in history are of the Great Depression and deflation. Unlike other parts of the world, we've never had a good hyper-inflation here and my guess is that we're about to get one.

As long as all paper money around the world is debased at roughly the same rate, most people will think things are fine - we'll have to get the Germans to cooperate.

What do you think Congress, the Fed, and the Treasury Department along with other similar organizations around the world are going to do - just sit on their hands as the entire financial system and global economy spirals deeper into the abyss?

The U.S. government is already on the hook for half of all U.S. mortgage debt for a housing market that is not likely to recover anytime soon - that's a pretty good start, but it's just the beginning.

Comments

[CLH:]

I agree with the first part of your post. You have come to terms with gold going down. After that you sink down into the usual rant about the end of paper money. The paper money will last much longer then either of us. After that --who cares.

2008 Aug 17 07:02 AM

[Gigem77:]

Lance Lewis writes for Minyanville and does a better job of covering the gold market than DePew. www.minyanville.com/ar...

Lance concludes: "as long as the Fed is forced to keep real interest rates negative in order to prop up the crippled U.S. banking system and U.S. economy then global inflation is going to continue to accelerate (especially if foreign central banks begin to ease as well), and that’s bullish for gold. As I have said repeatedly since last August, if the Fed and other central banks want to keep the financial system functioning in the wake of the housing bust, their only option is to inflate, period. That’s what they have done, and that’s what they will continue to do (no matter what they might “say” to the contrary). That’s the long-term trend to keep your eye on. "

2008 Aug 17 08:27 AM

[kkin365:]

I can understand gold's short term stress -- due to liquidation to meet margin calls in equities, etc. But the subsequent paragraphs, stating gold might go down to 600 or 500, are unsupported and, thus, puzzling.

2008 Aug 17 08:49 AM

[petersl:]

The prognostication that gold prices will descend as rapidly and as drastically as Kevin Depew predicts, is a possibility, no doubt. Whether it is a probability is open to severe question. If there is deflation in the wind, the response of central banks and governments who control currency policy for their respective polities, is to inflate or die. Weimar is too distant and too German a phenomenon to bother the priests in the temple, to do otherwise. This being the case, which I feel it is, precious metals are a good refuge. 5% in the metal in one's portfolio is a good place to begin. We are being handed a great opportunity to purchase some gold and silver at what will appear in the future to be bargain basement rates. I think that the downdraft in the prices, however, is still underway, so choosing an entry point will not be without its risks.

2008 Aug 17 09:28 AM

[waldipup:]

Anything can happen -

Gold can fly into the thousands , or drop below 500.

But nobody was hypothesizing that gold "can drop below 500 and still be in a bull market" before the recent part of this drop ,

nor was the economic analysis related to this presented.

Bottom line - Dont listen to no one , and allocate in an intelligent and diversified manner to be protected against all potential eventualities ,

Remembering, per various advice offerings, "nobody nose nutin".

"Still in a bull market below 500" may be a concept of intellectual interest , but aint no use to an investor being demolished by the drop to know that his investment is "still in a bull market".

2008 Aug 17 10:30 AM

[~6979~:]

With Oil coming down,its not hard to believe that gold is too.The correlation between oil and gold is unprecedented in our world.With Oil heading south, investors know that the overall market should recover.Plus there is more money on the sidelines than ever before in history,adding another unprecedented allure.

The % of Nasdaq stocks rising above their 200dms's just had a breakout friday.I expect that trend to continue in the short term.

Problem is, that Oil futures contracts are about to approach the most powerfulFibonacci support levelat 95.36,the 61.8% line.The bounce from that level has the potential to crush overall market bulls once again. There is also a shorter term Fibonacci line at 109.35.

Here is a link of many of my personally annotated charts of $GOLD,$NAA200R,$WTIC,a... many many others.

investorshub.advfn.com...

2008 Aug 17 11:16 AM

[johndaniels123:]

How can gold go to below 600 in a hyperinflationary environment? What about base production costs for gold, wont supply be held as the price drops? Gold at 500 means a super strong dollar; possible with a defaltionary trend. I agree there is some inflationary mask, and deflation symptome are apparent. Gold could drop temporariliy during htis trend. An I agree with the hyper inflatioanry overcompensation by the fed...Don't see gold dropping in the hyperinflationary trend.

2008 Aug 17 11:38 AM

[johndaniels123:]

I should add there are REAL supply demand issues as gold prices have dropped, even now. Physical supplies are being bought and sought after with greater urgency as the prices drop further. Meanwhile, sellers begin to hold back supply as the drops become worse.

True fundamentals will possibly create an artificially low price; where the price of gold is low but there is no supply. This cannot last.

2008 Aug 17 11:43 AM

[Alex Stanczyk:]

"I most certainly believe gold will eventually be an asset to own in coming years. However, at the onset of deflation, gold will be sold indiscriminately - like all assets - to pay down debt and repair balance sheets."

Bingo and right on the money.

www.rapidtrends.com/bl.../

2008 Aug 17 11:49 AM

[johndaniels123:]

One final point: IMHO the recent dollar strength is a marketwide deflation...And signals the collapse of the financial markets. As stated before, wall street gamblers don't know what will happen, the DOW price is insignificant; especially when considering the immense volatility. Housing is not getting better: there is a significantly lower willingness to speculate, Far less qualified buyers, more damaged credit reports, high real interest rates at 6.5%, dampened enthusiasm amidst the realization that there can be losses in housing, and the realization the housing without equitable appreciation is a loser; too many fingeris in the pie with real estate commissions, government taxes, post forclosure expenses, maintenance, insurance, HOA's, etc. Now the banks have to pay these fee's, out of pocket, as their debt money supply disapears. No housing recovery, no financials recovery.

2008 Aug 17 11:52 AM

[jabez:]

Barring an unlimited source of credit, can hyper-inflation occur in a system w/ no savings? Don't prices hit the wall very quickly, and to some extent en masse?

2008 Aug 17 11:58 AM

[NUCLEAR4WIN:]

If gold and oil rise and fall together, what happens when we eventually move away from oil, and start using alternative sources of energy? Will gold actually be valuated on supply and demand, instead of being bulked in with the rest of the commodities? I just do not understand how gold is being pushed down so fast when our government is printing out money like it is made from the Monopoly game. By the time our government bails everyone out and gets done printing out these BILLIONS of dollars, why will the U.S. $ be worth anything? And wont this send the price of gold through the roof?

2008 Aug 17 12:30 PM

[User 30121:]

What I have been experiencing (the past 6 decades) is that "when all is well in the world...financially and politically speaking, gold is a sleeping giant. However, when there is turmoil in the world the likes of the above, the sleeping giant (gold) awakes and heads for Mt. Everest! All you posters like--CLH-- that think the almighty dollar is KING, and the digital "printing presses" going 24/7 are just a wonderful event to behold, than please WATCH OUT! Because your demise is just around the corner!!!!!

2008 Aug 17 05:34 PM

[Jimbo:]

I was told by a coin dealer this past Thursday that the U.S. Mint had stopped selling newly made gold coins to individuals. The Mint may still be selling to a limited number of coin dealers.This suggests that there may be a shortage of physical gold.There seems to be many confusing crosscurrents:: Milk and other foodstuffs going up, utilities going up, while certain assets, such as real estate, going down.

2008 Aug 17 06:21 PM

[Kelly Liebe...:]

Thursday August 21 2008 Wake Up Call For America:
I.O.U.S.A.: LIVE with Warren Buffett, Pete Peterson & Dave Walker
8/21/2008
Fathom and Roadside Attractions present I.O.U.S.A.: Live with Warren Buffett, Pete Peterson & Dave Walker in an exclusive one night event in select movie theatres nationwide on Thursday, August 21st. This event will include the critically-acclaimed documentary, I.O.U.S.A., and a LIVE discussion about America’s economic crisis and what we can do to change course.

This one night event will be shown LIVE at 8:00pm ET / 7:00pm CT / 6:00pm MT / and tape delayed at 7:30pm PT.

Average ticket price ranges between $11.50 and $20, depending on location. Use the zip code search above to select from a list of participating theatres in your area.

The live discussion with America’s most notable financial leaders and policy experts, including Warren Buffett, CEO of Berkshire Hathaway; William Niskanen, chairman of the Cato Institute; Bill Novelli, CEO of AARP; Pete Peterson, senior chairman of The Blackstone Group and chairman of the Peter G. Peterson Foundation; and Dave Walker, president & CEO of the Peter G. Peterson Foundation and former U.S. Comptroller General, promises riveting dialogue and keen insight into the crisis we currently face. The panel will be moderated by Becky Quick, co-anchor of CNBC’s morning news show Squawk Box.

From the producers of Wordplay and the studio that brought you Supersize Me, the must-see documentary I.O.U.S.A. uncovers the source of critical economic concerns that touch the lives of every American. A tapestry of archival footage, hard data and candid interviews woven together, it paints an authentic profile of today’s economic condition. Solutions for how we can impact this nationwide crisis and evolve into a more fiscally sound nation for future generations are offered by the documentary’s powerful conclusion.

“May be to the U.S. Economy what An Inconvenient Truth was to the environment.” - Reuters

Just imagine the panic as the press gets a hold of this one... Finally, the world will be shocked into a reality that has been withheld from us. The truth will be very painful for many.

I urge everyone to make it a point to see this film, and I would hedge my bets and make sure I bought metals on Monday before the tidal wave hits...

2008 Aug 17 06:47 PM

[User 30121:]

Kelly...(we've) been telling those willing to listen (and ponder) that BUYING and taking PHYSICAL POSSESSION of SILVER and GOLD will save their bacon! Obviously, some are doing just that. When the MASSES "see the light" I (we) will be SELLING to them. That's the plan, right?

2008 Aug 17 06:55 PM

[Kelly Liebe...:]

30121..
That is my plan as well.... Can't help trying to help a few along the way.. There are many more that just read the posts and never comment, so hopefully we are helping somebody out there.

2008 Aug 17 07:06 PM

[ussmls7:]

Paper money is just that,no matter if it takes 1million to buy a oz of Gold or 1000.00 to do the same! Inflation is real, & what has always been money ? Gold & Silver ! When a million dollars is only worth 4 cent on the dollar, what do you want in your pockets?

2008 Aug 17 08:33 PM

[Steven Hansen:]

I hope everyone realizes this article is an editorial, and has little fact to make an informed decision on gold. Whatever the reasons, gold is not behaving as a asset preservation vehicle - nor is it acting like a psuedo currency in this time of financial turmoil. Could this be the reason some are abandoning their positions on gold?

2008 Aug 17 08:35 PM

[Blair:]

If you look at the long term charts, a 50% retrenchment calculates to (roughly) $625. Examine the charts, this dollar value lies within what should be a support area.

A 33% retrenchment calculates to roughly $780, which again should be a support area.

One will know where gold bases out with hindsight. By the way, these estimates are based on London gold prices.

Some of the discussions are interesting. My surmise is that many leveraged gold buyers are being faced with margin calls, and consequently are dumping or being required to raise cash through selling assets that have held up in this recent bear market.

2008 Aug 17 08:38 PM

[Dennislaw:]

Thirty Pieces of Silver
I would rather hold any physical commodity than any fiat currencies.
The Aussie Dollar is my favorite currency.
All the countries commodity resources.
Stable rule of law.
Proximity to Asian trading partners.
Conservative thinking Fed.
But with all that said... like most countries the politicians have over promised.
Get your thirty pieces of silver just don't betray yourself to get them.
Live long, happy and prosper.
Always remember- Money is only a medium of exchange.
Gold is the standard.

Jun 14 04:57 PM