"I have never been a gold bug. It is just an asset that, like everything else in life, has its time and place. And now is that time."
~ Paul Tudor Jones (2009)
"Amazingly, people are paying Switzerland to warehouse their money for ten years. That makes gold a high yielder, because it yields zero…"
~ Jeff Gundlach
"The People's Bank of China will continue to implement a prudent monetary policy maintained to an appropriate degree, guide monetary credit and social financing to steady moderate growth, and promote the smooth operation of economic health."
~ PBOC statement, Feb 4th monetary policy easing
The subject matter that follows should please a good number of our readers and colleagues. We now set out to unpack the rationale for doing a 180 on gold (NYSEARCA:GDX). For a good length of time we were unabashed bears on the yellow metal. Now we are bulls (and aggressive ones at that). But before we talk profit opportunity, some points of clarification are in order. One might say a mini-rant is called for, in the name of conscience. (Many of our views are blunt and unpopular… we're no good at holding them back, so why start making an effort now.)
There is very little consumer protection in markets. Investors and traders, for the most part, are free to buy and sell what they like. Yet if the SEC were more like the FDA, certain asset classes might have warnings on them like cigarette packs. In particular, gold would deserve a warning like this:
WARNING: Ideology is hazardous to your wealth. Trading or investing based on political theories, emotional attachment to a "school of thought," scorn for government entities, or irrational desire to see a socio-economic group get their "just desserts" is a proven means of losing objectivity (and money).
Emotional decision-making is generally recognized as a bad idea in markets. Yet many investors let ideology drive their portfolios, ultimately at great cost. (Nor is it just investors: As we have said in these pages, the euro was one of the worst decisions in the history of finance, championed for reasons of ideology when it was clear the idea would never work.)
Gold is hazardous because its assessment is usually tied up in politics… and politics, for many, have the same emotional appeal as sports. It is all too easy to identify with a particular theory, or way of seeing the world, in the same manner as a sports team (i.e. with great loyalty and emotion involved). Sports and politics are also great outlets for tribal loyalties - the fundamental human need to believe in something (or "belong" with an affiliated group). This is all quite dangerous.
That said, the most basic reason to be bullish on gold is this: Price has stopped going down, and now shows sign of going up again. The gold price has broken a 27-month downtrend (which began in October 2012). And yet there is more here than meets the eye. Gold's turnaround is more impressive than it seems, given the substantial headwind of a massive run in the US dollar (DXY). Those of you who have read the SIR for any length of time know the greenback is a juggernaut these days. Dollar strength typically translates to gold weakness. Not anymore: A recent comparison showed that, since the beginning of the year 2014, gold was up roughly 6% in US dollar terms… but more than 19% in yen terms and nearly 30% in euro terms. If gold has held up this well against a skyrocketing greenback, what happens if the dollar stalls?
As Jeff Gundlach has joked, gold is now "high yield" because it boasts a yield of zero (i.e. not negative). That's better than what's available from the Swiss National Bank on a ten-year basis, and many others on a two-year basis. The attraction of havens is now so strong, even corporates are going negative. Short-dated corporate bond yields for Nestle SA (OTCPK:NSRGY), the Swiss chocolate maker, are predicted to fall below zero as a result of the Draghi push for "euro QE" (sixty billion per month). It does not take a genius to see that the world is a screwed up place when yields across the globe are near zero or below. To better understand the dangers of ideology, all traders and investors would benefit from reading "The True Believer" by Eric Hoffer. Written in 1951, "The True Believer" looks into the nature of mass movements - fanatical or extremist cultural movements rooted in religion or politics. It describes how commitment to a cause (or belief system) is often rooted in emotional needs (or lack of self-esteem). A core theory of the book is that mass movements are interchangeable: It is the zealous fervent need to belong and identify with a group - while rallying in fierce opposition to some other group - that matters more than the substance of the movement itself. There is a sense of energy, vitality and purpose that comes with belonging (like cheering for a sports team times 100).
Gold is further prone to the "simple solution to a complex problem" fallacy, in which some thorny political problem is deemed solvable "if only the authorities would do X." As in, "if only we went back to the gold standard" our pressing monetary issues would be solved. This oversimplification of complex issues ties directly into the politics-as-sports idea, which is why politicians love soundbites. Simple solutions are intrinsically appealing due to a brain quirk: As professor Daniel Kahneman explained in "Thinking Fast and Slow", when the mind cannot find the answer to a challenging question, the natural response is substituting an easier question! So the question of "how we do improve monetary policy" is substituted with, say, "how do we keep politicians from spending"… a much easier question to answer in theory (if not reality), without addressing the deeper problem at hand.
Gold as a problem-solving panacea further falls under the "non-falsifiable hypothesis" category, meaning a hypothesis can be forever championed as long as it is never tested. To give a quick tongue-in-cheek example, your humble editor could assert that if only, say, Britney Spears were elected president of the United States, all major political problems would be solved. Some rationale could be concocted - the benefits of gridlock, bringing humor to the political system and so forth - and from there the view could be held onto permanently, all objections answered with rebuttals, as long as there were no way to actually disprove the idea in the real world. Every challenge could be met with some variation of "We haven't tried it" or "But such-and-such proves my view."
The intention is not to single out gold bugs. Many groups, on all points of the political spectrum, are guilty of falling in love with their particular brand of vodka. One can worship, say, the notion of making corporations stop polluting as easily as one can worship gold. Our main point here is that all forms of "worship," or emotional affiliation to an ideology for that matter, are dangerous when it comes to investing. We are highly allergic to ideology because ideology is expensive!
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The best way to understand the yellow metal, in our view, is this: Gold is a specific type of insurance - a sort of "Credit Default Swap" against central banks. Gold has no yield or cash flow or productive use… but neither does an insurance contract! Gold is ignored or shunned when central banks appear to be in control… just as CDS on strong corporate debt will have limited appeal as long as things appear fine.
Imagine a liquid tradable market for hurricane insurance on Florida beachfront property. The value of a blanket insurance policy would trade up and down (just as CDS contracts fluctuate in value). As long as the weather is nice, the market would be sleepy. If the weather persisted in being nice for years on end, the market would downtrend. But then what happens if ominous pressure systems start to form? What happens if an actual hurricane seeds itself down the coast? This is precisely analogous to what may now be happening with gold. In the thick of the Bernanke years, global central banks were hailed as heroes, reining supreme. Now, though, with interest rates zero or negative around the world… and lack of growth a sticky problem… they appear to be losing the plot. What happens if all the extra stimulus does no good? What do the bankers do if they throw everything but the kitchen sink at the lack-of-growth problem… and deflation and recession conditions persist? This is the stuff of panic. It is the stuff of a hurricane formation not far from shore.
In the first 34 days of 2015, Bloomberg reports, the following central banks have all cut interest rates: Australia, Canada, Russia, India, Peru, Pakistan, Turkey, and Egypt. In addition, of course, we have the historic "euro QE" decision of €60 billion per month in perpetuity… and as this SIR issue goes to press, the People's Bank of China has just poured on more stimulus by cutting its required bank reserves. "We expect at least four more cuts in 2015," reports Shen Jianguang, chief Asia economist at Mizuho securities, "in view of the prospect of further deceleration in economic fundamentals." China saw its largest capital outflows since 1998 last quarter.
The question is what happens when all of this Hail Mary liquidity fails to revive growth - as it likely will not - with so many economies already near stall speed, and rates at or below zero. There is also question as to whether the United States - the lone "engine of growth" in a world of stagnation and slowdown - can continue to power on solo. It is fairly obvious now that central bankers, those wise and omnipotent beings who have controlled markets these past few years, will have no idea what to do when epic amounts of liquidity fail to solve their basic problem. It is said that gold does well in deflationary environments because gold is the only currency not subject to the whims of a printing press. Right now USD is the lone paper not being debased. To wager on central bankers' epic fall from grace, buy gold…
The above was broadcast on February 4th, 2015 via the Strategic Intelligence Report "SIR".
Disclosure: The author is long GDX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author is also long the dollar against a basket of currencies.