Why The Pause In Gold's Rise Is A Positive

Includes: GLD, SGOL
by: Mark Thomas

Why it’s good that gold prices stopped rising

This year has seen a spectacular rise in the price of gold especially in relation to the performance of stocks in general. Year-to-date as of Monday’s close gold priced in US dollars was up approximately 27.4%, while the S+P 500 has declined 5.4% including dividends. Those figures are approximate based on the Swiss Physical gold Shares gold ETF (NYSE:SGOL) and the SPY S+P 500 ETF (NYSEARCA:SPY). However the outperformance of gold has been a staggering 32.8% in less than nine months, or on average about 3.85% per month so far this year. That is why it is difficult for us to understand why most fund managers and financial pundits still cling to owning stocks, despite these facts.

We used to be the same way because we had only been trained in paper financial assets and weren’t even in High School during the last bull market for metals. However eventually this outperformance forced us to unlearn our previous experience, learn about investing in non-paper assets for the first time, their history and most importantly their relationship to bad fiscal and monetary policies. Now that we have done exhaustive research, placed very large bets on metals and have been handsomely rewarded, a whole new world of investment opportunities has been opened to us during these multi-decade cycles where real assets outperform paper and then the cycle reverses itself. We feel so strongly about what we have discovered that we started a newsletter service devoted to the subject that can help any investor, whether a novice, professional, individual or even institutional investor. We invite you to embark on the difficult but very rewarding same journey that we have so that you can properly position your investments to profit from the current situation and turmoil.

Since June 30 2011, the price of gold has been on fire, advancing 20.9% as of Monday’s close. During that same time period the S+P 500 has fallen by approximately 11.6%. So gold has outperformed the S+P 500 by 32.5%. Remember those numbers the next time you hear a financial pundit on television or read one in print suggest that gold is an irrational investment and stocks are “undervalued.” As investors who are currently 100% personally invested in precious metals ETFs and any stocks we own are all precious metals mining stocks, this has been one of our best periods of relative outperformance in our entire twenty plus year careers. When the market confirms your investment thesis, which others were scoffing at and still call us crazy for employing, it is nice to see our hard work and conviction pay off so much.

We thought we would now take a step back and take a look at the pause in the rise in prices in the gold market after such dramatic moves higher in the last few months and why that is actually a very healthy thing for the bull market in precious metals. While everyone who has been wrong by not owning them declares an “end to the bubble in gold prices,” we view a pause, stabilization in prices and the building of a good base at these levels as an essential step for the bull market to continue over the next few years. While many have already declared an end to the bull market or “bubble” in precious metals prices it has only pulled back 4.9% from its recent high around $1927. Of course it is exciting to see your portfolio rise almost every day especially as others are losing, it is not healthy when it starts feeding on itself and becomes unsustainable. Let’s look back at gold’s dramatic rise in price and how much gold prices rose each week for the last few months:

Week of % price rise or fall

July 5-8 1.78%

July 11-15 5.16%

July 18-22 .005%

July 25-29 .0061%

Aug. 1-5 2.21%

Aug. 8-12 5.0%

Aug. 15-19 5.85%

Aug. 22 2.5% rise in just one day.

Since the investable gold market is at least $1.5 trillion in size, it shouldn’t move more than 2%-3% in a week. The gold market moved more than 5% higher in three of a total of just seven weeks. Then when it peaked for the first time around $1917, gold moved up 2.5% in just one day. Obviously when the markets were gripped with fear and with gold the only refuge from falling stocks and currencies, we understand why the moves became exaggerated. When you combine the fact that during this period it didn’t have a more than 3% pullback, that was a very extreme move that started to become unsustainable. However a move in the price of an asset where the rate of acceleration keeps increasing (a parabolic move) never ends well. We saw that in the much smaller, more volatile and easier to manipulate silver market from February to May of this year. The gold market was starting to become similar to that market - attracting too many new investors for non-fundamental reasons like momentum and fast money hedge fund types.

For those of us who really believe what is going on in gold is much more profound than just a normal bull cycle and that stocks are in an equally negative cycle, we want the final parabolic move up in gold prices to begin at more like $2500 to $3000 and take the price up to over the $5000 level. We don’t want that parabolic to begin now! That is why it is a good thing gold is testing some of the new investors, shaking out some momentum fast-money types.

We hope that gold now trades in a consolidation range and builds a base here between $1750 to $1925 for a few months. That is what is necessary for a continued healthy bull market in gold. We know it was disappointing short term when gold prices stopped rising. However you should stay focused on the bigger long-term prize of much higher prices over the next few years, not the next few weeks or months.

Disclosure: I am long GLD, IAU, PHYS, CEF, GTU, NEM, KGC, ABX, GFI, HMY.