Which Side Of Goldman Sachs Is Right About Gold?

| About: SPDR Gold (GLD)
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Now, some of our clients are speculating that the price of gold will rise in the future. And we have other clients who are speculating that the price of gold will fall. They place their orders with us, and we buy or sell their gold for them...The good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions. Randolph Duke, from the movie "Trading Places."

The head of Goldman Sachs's commodity research, Jeffrey Currie, reiterated his "sell" recommendation on gold today with a price target of $1050. Interestingly, and in direct conflict with Currie's market call on gold, Goldman Sachs Group (NYSE:GS) filed an SEC 13-F disclosure at the end of June, which revealed that GS purchased over 3.7 million shares of the SPDR Gold Trust (NYSEARCA:GLD) during the 2nd quarter, making GS the 6th largest holder of GLD. Clearly there is a difference of opinion within the firm regarding the outlook for the price of gold. As an investor should you follow the guy selling research or do you follow the money?

Currie issued a "sell on gold originally on September 13th, citing the Fed's "taper" and an improving economy as his reasoning. Five days later the Fed deferred on tapering and gold is now 2% above where it was ($1296) just before the September 18th FOMC policy statement. For reference, the S&P 500 is 1.5% below where it was right before the FOMC policy release. As for the economy, I have published two recent articles documenting, with hard data and analysis, fundamental evidence that the economy - contrary to Currie's view - is actually starting to slow down quickly. The first one covers decelerating auto sales in August, which was further confirmed with September's auto sales data. The second article documents several economic data reports showing the economic slowdown that is occurring. I also suggest that the Fed will likely defer any taper indefinitely and it might in fact be forced to increase QE. In other words, Currie's original two premises for issuing a "sell" on gold are not valid.

Today Currie reiterated his "sell" on gold, with the explanation that, once the budget and debt ceiling "stalemate" is over, "significant [economic] recovery in the U.S. and tapering of QE should put downward pressure on gold prices." While I agree that gold might get sold off briefly once the budget/debt ceiling impasse is resolved, I have not seen any recent evidence pointing to any kind of economic strength or any signs of recovery. Furthermore, with a much higher debt ceiling and increased Treasury debt issuance that will be required in order to fund a higher level of Government spending, it is far likelier that the Fed will be forced to increase its Treasury debt purchases rather than taper at all.

Notwithstanding whether or not you might agree with my view on the economic outlook or the prospects for more QE, it turns out that while Jeffrey Currie is out issuing his "slam dunk" sell recommendation on gold, the money trail shows that Goldman Sachs Group increased its holdings in GLD from about 650,000 shares to over 4.4 million shares during the 2nd quarter this year (link above), making GS the 6th largest holder of the gold trust. What intrigues me about this is that, without knowing or trying to second-guess Currie's motives for his bearish call on gold, Goldman's actions speak much louder than Currie's words. Just like it's always helpful to know that insiders are buying a company's stock when you decide to invest, for me it's helpful to add to my gold positions when I know that a big Wall Street firm is committing real money to the same side of the trade.

While I've addressed why Currie is wrong in the links above, I see a few fundamental reasons why GS is buying GLD. First, as many are probably aware, a couple of months ago the Indian Government placed heavy restrictions on gold imports into India, practically halting the flow of gold into India. But India is entering its seasonally strongest period of gold buying and the Government has loosened up restrictions, which could unleash a huge amount of buying:

India's gold demand could rise as much as 15 percent this quarter to 300 tonnes as pent-up demand following a good monsoon keeps the country on track for yearly demand estimated at 1,000 tonnes. World Gold Council

For point of reference, the World Gold Council has historically underestimated Indian gold demand annually. If in fact, India's demand for gold bounces back to at least 300 tonnes during the 4th quarter this year, it will put a lot of upward price pressure on a physical market that is already stressed with supply shortages from China's voracious demand. In fact, it was reported yesterday that Indian gold importers have started processing orders ahead of the festival and wedding season.

Speaking of China, you can see from this chart below (from In Gold We Trust, data from the Hong Kong Census), that China has already imported more gold in 2013 through July than in all of 2012:

(Please note that the gold imported into China through Hong Kong does not include any gold that may or may not have been purchased by the Peoples Bank of China - China's Central Bank - as any gold imported by the Government is not reported). If you assume China continues to import gold at the same rate for rest of 2013, it will have imported over 1300 tonnes. Adding this to the estimate for India would mean that China and India combined will have imported more gold (2300 tonnes) in 2013 than is estimated will be produced by all gold mines globally (2200 tonnes).

In other words, demand from China and India alone in 2013 has and will continue to exert a lot of pressure on the supply of physical gold. And this doesn't take into account all the other eastern hemisphere/BRIC countries in which the Central Banks are accumulating gold.

In addition, China's Government is implementing new policies designed to expand and promote gold importation into the country:

China's central bank is planning to increase the number of firms allowed to import and export gold and will also ease restrictions on individual buyers of the precious metal. China Eases Gold Trade Restrictions

At the very least, demand of physical gold from just India and China will put a floor under the current price of gold, making Currie's forecast of $1050 - in my view - highly improbable. But I also strongly believe that over the next few months - away from any geopolitical and economic factors - the demand for gold from the countries that are big buyers will exert upward pressure on the price.

Finally, I want to discuss two factors away from eastern hemisphere physical demand and U.S. economic/political considerations, which support the view that gold has bottomed and is headed much higher. First is investor sentiment. As you can see from this chart, sourced from analysis posted by Clive Maund on 321gold.com, the public sentiment toward gold is extremely low - which is bullish from a contrarian standpoint:

This chart is reinforced by Marketvane's Bullish Consensus for gold, which is a very low 41% and the Hulbert Gold Newsletter Sentiment Index, which is negative 20, indicating that investment newsletters are recommending a net short position in gold and mining stocks. In other words, based on public opinion and investor sentiment levels, anyone who wanted to sell their gold positions has probably already done so, which means that it is likely the next move in gold is up.

The second factor is the U.S. dollar. As the 2-yr. daily dollar chart below shows, the dollar index has been clinging precariously to the 80 level for the past few days:

The dollar reacted quite bearishly when the Fed announced that it would defer tapering QE and shortly thereafter the 50 dma crossed below the 200 dma shortly thereafter. This "death cross" is considered to be a very bearish technical signal to traders and we can expect that forex traders and speculators will be selling long dollar positions and building short positions on every intra-day rally. The significance of this is that over the past few weeks gold has started to move more inversely in relation to the dollar:

The trend in the 1-month rolling correlation with the dollar has now reversed: the level is back in the middle of the range at -0.54. This suggests that gold is currently better positioned to benefit from any dollar weakness ahead than it was over a month ago. (UBS-London Precious Metals Daily).

In other words, we can expect that gold will tend to move higher on days when there is dollar weakness. If I'm right about the Fed eventually increasing QE to accommodate a higher level of Treasury debt issuance in order to keep interest rates contained, the dollar is going to take a beating and gold will, conversely, experience a dramatic move higher. This scenario could well play out within the next 4-8 weeks.

While Jeffrey Currie's flashy "slam dunk" sell recommendation on gold makes for attention-grabbing headlines, it lacks support from any kind of substantive fundamental analysis. Not only that, it stands in direct conflict with the fact that Goldman Sachs has assumed a large long position in GLD. Contrary to Currie, I have laid out my view for why I think gold is poised for a potentially big move higher and I have at least laid out several fundamental factors that could trigger this move.

If you agree with my view, I first and foremost recommend accumulating physical gold in the form of 1 oz. sovereign-minted bullion coins (gold eagles, maple leafs, philharmonics, etc) that you safe keep yourself. If you want to also try to generate trading profits, the least risky way to index the price of gold is to buy GLD. More speculative vehicles include the PowerShares DB Gold Double Long ETN (NYSEARCA:DGP), which is 2x gold, or the VelocityShares 3X Long Gold ETN (NASDAQ:UGLD). As I mentioned above, gold could briefly sell-off when the budget/debt ceiling impasse is resolved, but I would use that as opportunity to buy into the speculative trading plays.

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.

Additional disclosure: The fund I co-manage trades GLD, DGP and UGLD