Zero Hedge Is Wrong About Gold

Includes: GDXJ, GLD, SLV
by: Bleecker Street Research

The pain and uproar that surrounded gold in the spring of this year has largely faded away now. With the markets continuing to new all-time highs, Tesla's (NASDAQ:TSLA) catching on fire, and the Twitter (NYSE:TWTR) IPO, gold is no longer in the spotlight as it was earlier in the year. It rebounded nicely after the mini-crash, but has still been one of the worst performing sectors this year.

It has obviously been a rough couple of years for gold investors, and gold (NYSEARCA:GLD) is now down nearly 40% from its peak of $1,920/ ounce and Silver (NYSEARCA:SLV) is down 50% from its peak of $50/ounce. gold miners have suffered even more, with the gold Miners ETF (NYSEARCA:GDXJ) down 53% YTD and 83% from its peak. These miners suffered when they took on a lot of debt to finance mining projects and then the price of gold fell, making it almost impossible for many of these companies to turn a profit. I have no stake in gold or silver, although I do own a very small amount of physical silver that was given to me. Generally I am skeptical of Gold, as I explained in an earlier article, I believe many people bought or pitched buying gold using a faulty economic structure.

When people heard the Fed was implementing a third round of quantitative easing, they thought that the size and open ended nature of it would certainly cause inflation. If people would stop equating money supply with monetary base and really understood how the Fed implemented monetary policy then they would have a much easier time investing, especially in regards to precious metals.

What really drives inflation is lending, but that is not the point here. The point is that I thought that many people were using incorrect economics to justify gold prices. Then yesterday I read this article from Zero Hedge titled "Is The Perfect Storm About To Come For Gold?" In it he argues that the Fed has been manipulating the price of gold for the last 30 years, which I entirely disagree with, and that we are on the cusp of a great bull market in Gold.

(Click to enlarge)

This chart looks a lot like another chart, Tesla's chart this year.

(Click to enlarge)

I only include Tesla because I find that most Tesla fans could care less about Gold, and most Gold-bugs think Tesla is overvalued. To defend their argument that gold is on the cusp of a bull market, Zero Hedge makes the following arguments.

The last shoe to drop is for major mining companies to start closing down production at major mines. Though this would be perceived as the end for gold, speculators will be happy to know that this would be the beginning of the biggest Fed induced bubble in history! But unlike previous Fed bubbles where they support the price increase, the gold bubble will be a result of western central planners mismanaging the gold price for the past 3 decades and finally losing control.

I partly agree and partly disagree with this statement. The part about western central planners mismanaging the price of gold over the past 30 years is ludicrous in my opinion. For one, the 30 year chart of gold looks quite nice. And it is up around 250% in that time frame. Were there better investments to make? Sure. But a 4% annualized gain when compared to an average of 6% for stocks historically is not bad at all for something that most people have a small allocation to as a hedge for crises.

The first part of the statement I wholeheartedly agree with, in fact I was surprised that Zero Hedge suggested that many people would react negatively to it. If I wanted gold to go up I would be actively rooting for many of these miners to go bankrupt. It is simple supply and demand. The higher gold prices attracted more miners, which increased the supply, which caused the price of gold to go down, which will cause the weakest gold miners to fail. With the weakest miners with the worst balance sheets going first. Then when those are off the market and no longer adding supply to the global gold market, the price will rise. That is simple supply and demand. Ultimately, however, gold is worth what people are willing to pay for it. There is always a buyer and there is always a seller. Just because a handful of small miners go bankrupt does not mean that the price of gold will rise.

The Catch

While I agree with the basic premise that less gold miners (and therefore less gold production) would be a positive for the price of gold, it can be more complicated than that. For example, according to GoldSeek, gold production peaked in 2001 and bottomed out in 2008.

Source: Gold Seek

However, if you look at a 15 year chart of gold you will see that the supply of gold was the greatest right before a fantastic bull run, and the supply was the lowest right before a crash.

Of course you can say that those times were different, just like you can say that every time, I think it is proof that just because there is a lot of supply of something on the market doesn't mean it will go down in price or vice-versa. It all depends on what people are willing to pay for that supply. I believe that is the weakness in Zero Hedge's argument. If people aren't willing to pay more for gold, then it will not go up, at least in the short run.

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.

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