Many investors mistakenly confuse price with value. Prices change every day. Value is more difficult to assess since it does not blink on a Bloomberg screen, but it is critical to understand the difference. As Warren Buffett has noted, Price is what you pay. Value is what you get.
Back in October, we outlined our long-term constructive view on gold here. Let us be clear – we are in no way altering our thesis and remain quite happy with the label “gold bug. In fact, we could easily make the case that the fundamentals are stronger today than when we first discussed the yellow metal. However, what has changed, is price. And what a mighty change in such a short period! As a proxy for the space, GLD, GDX and SLV have rallied 20% – 25% to their most recent peaks. After such a rapid gain, we would not be surprised to see precious metals take a breather. Extreme optimism is now evident in various sentiment measures, so a consolidation period is likely at a minimum. We shall see . . . but a part of us is hopeful for a large enough pull back to add to our core position in the oldest store of value.
Recent comments from Gluskin Sheff’s David Rosenberg support this view:
Gold just capped off its best month in a year – ±14% in November and 34% year-to-date. It’s not just the middle-class in China that is starting to buy gold, but the central bank, which has very deep pockets, is going to do likewise. We just came across a Bloomberg News article quoting an official from the state-owned Assets Supervision and Administration Commission (Ji Xiaonan, the Chief) as saying “we recommend China increase its gold reserves to 6,000 metric tons within three-to-five years and possibly to 10,000 tons in eight to 10 years.” China’s reserves, after a 76% buildup since 2003, currently stand at 1,054 tons, so we are talking here about the prospect of some pretty heaving buying in coming years.
If China were to lift their gold reserves to 5,000 tonnes, which is equivalent to about two years of global production, that shift in demand would boost the gold price by $800/oz to around $2,000 ($1,978) based on our models. If China moves towards 10,000 tonnes, well, that would end up taking the gold price to $2,623/ounce if our calculations are in the ball-park.
Make no mistake, we are gold bulls. Central banks have deep pockets and production of gold is stagnant so the demand-supply backdrop for bullion is bullish. At the same time, we have to pay respect for market positioning over the near-term. The market for precious metals is overextended right now after the parabolic move of the past two months. The net speculative long position has swelled to a record 273,552 contracts (100 ounces each) on the COMEX. Open interest has never been higher, at 693,661 contracts. So this is one crowded trade – as is the short-trade on the USD against all the major currencies, especially the commodity-based units.
So, we could get a meaningful gold correction at any time, and we are talking about a correction in what is still a secular bull market – the 200-day moving average is $970/oz, which means we could get as much as a 20% pullback and no fundamental trendline would be violated. We remain long-term gold bulls, and our commentary remains fundamentally bullish, but anything that could spark a countertrend rally in the U.S. dollar, which is our principal near-term concern, would put gold at a much better price point for investors than the peak we are at today.
Disclosure: At the time of publication, author was long streetTRACKS Gold Trust Shares, Market Vectors Gold Miners and iShares Silver Trust, although positions may change at any time.
Disclosure: Long GLD, GDX, and SLV