Gold: I Hate To Say I Told You So ... But I Told You So

Includes: GLD, IAU
by: Robert Wagner


The graphic highlights how even the mainstream media is now aware of the fear, panic and collapse occurring in the gold markets. In mid-March I wrote a piece highlighting how the "stars were aligning against gold." In it I attempted to document many factors that were pointing to a lower price for gold and SPDR Gold Trust (NYSEARCA:GLD). I followed it up with another article highlighting how the "stars continue to align against gold." When I saw the Bitcoin collapse, I thought to myself that it was only a matter of time before gold followed.

Both the Bitcoin and gold share a fatal flaw. Much of their value is/was based upon the perception/myth that the US Dollar was risky and that alternatives like the Bitcoin or gold offered a better solution as a currency. With the collapse of the Bitcoin from over $260, to under $100 is little less than a week, and gold now off more than 20% from its high, that myth is forever shattered...or at least is should be.

Both the gold standard and Bitcoin are "inelastic" currencies. Inelastic currencies don't expand and contract with the economy. Both the gold standard and the Bitcoin, if applied to the economy as a whole, would most likely result in a deflationary environment. Talk to a gold standard or Bitcoin supporter and they most likely will tell you the appeal of those systems is that it is deflationary, not like the inflationary Federal Reserve and their "fiat" money. Terms and phrases like "intrinsic value,""printing money out of thin air," and "Waimar Republic" will also likely be included in the conversation.

Convincing people that mild inflation is good and deflation is catastrohically bad is a very difficult thing to do. Even more difficult is convincing them that the Federal Reserve is doing an outstanding job. It prevented a catastrophic banking collapse back in 2008, has prevented the economy from falling into a deflationary spiral, not a single penny of insured deposits has been lost and has maintained the US Dollar's value and status as the world's reserve currency. Compare that to the Great Depression, and what could have happened, and by almost all measures, the Federal Reserve has done an outstanding job, and should be commended, not attacked. Have all our problems been solved? Absolutely not, but no amount of sound monetary policy can compensate for insane fiscal policy, bickering, confusing and constantly changing rules and regulations coming out of Washington.

It is also important for people to understand that the Federal Reserve doesn't spend our tax dollars, Congress does. The bonds backing the US debt have "Treasury Department" stamped on them, not Federal Reserve. If you are angry about the debt, talk to your Congressman or woman and leave Ben Bernanke out of it. A proper diagnosis of the problem is required to establish a successful treatment plan for any illness. By attacking Ben Bernanke and the Fed for the debt only allows the cancer that resides in the Congress to grow.

Hopefully, with the collapse of gold (currently trading below $1,400) and the Bitcoin (currently trading below $100), we can permanently debunk the myths of gold and Bitcoins being better alternatives than the US Dollar. Whereas both gold and Bitcoin have demonstrate extreme volatility over very short periods of time, something that effectively disqualifies them as viable currencies, the US Dollar has been in a relative tight range since 2008, and is actually higher than the 2008 low, and that is AFTER all the printing of money for the QE operations. In my opinion, much of the sell-off in gold and the Bitcoin is the market discounting the fact that it is now apparent the currency value priced into them isn't justified. The US Dollar is the currency of choice, not gold or Bitcoin.

Going forward, Michael Haigh, global head of commodities research at Societe Generale, makes the exact case I did when I wrote the stars aligning articles, and is classic economic and currency analysis. As the economy rebounds, interest rates should head higher. Higher interest rates will drive the US Dollar higher. The higher US Dollar will drive gold down, and higher interest rates provide an alternative to gold that also pays interest. A higher US Dollar and higher interest rates also help keep a lid on inflation. All are bearish for gold. To make matters worse for gold, another main support of gold is QE, and it looks like QE may be coming to an end. If interest rates do increase, bond prices will fall, but gold is behaving like a leverage long-bond, so even though bond prices will fall with increasing interest rates, gold will likely fall more, and bonds pay interest and you likely get your money back at maturity. The same can't be said about gold, so as rates rise, gold will suffer by it "Treasury Envy." Gold simply doesn't measure up, if the US Dollar and interest rates begin to rise.

In conclusion, in my opinion, the gold rally is most likely over. There may be some retracements of the recent correction, but I doubt that gold will approach its old time highs anytime soon. More and more stars are aligning against gold, and now that gold has entered bear territory, and investors that previously thought gold could only go up are getting a very rude awakening that the "intrinsic value" of gold can also go down. Once the invincibility myth, the currency myth and anti-Fed myths are debunked, there isn't a whole lot to hold the value of gold up. The markets are awakening to the fact that their golden emperor has no clothes. Historically gold is valued as a hedge against inflation. If the markets get back to the classic relationships, I would imagine gold has much further to fall. Facts are, if the Fed does its job, and restores growth without inflation, there really aren't many more arguments for paying over $1,300 for a Wheat Thin sized piece of basically useless metal. Bottom line is, a bet on gold is a bet against the Fed, and one of the best known axioms on Wall Street is "don't fight the Fed."

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I 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.