Early in the week, it appeared to me that gold was topping out, at least in the short term, so I liquidated most of my GLD calls. I blew out the rest on Thursday after the $35 plunge. I have long-term positions that I have not touched. I will look to re-establish positions in GLD calls in the future.
Paul Kedrosky has an excellent post on gold being underowned compared to the last big financial crisis.
I have had several conversations with investment professionals over the past few days regarding gold. I have been asked by people in the investment business what they should do with their money, given the low prospective returns for most asset classes. I asked them if they are invested in the only bull market going, gold. The response? Skepticism. All but one said "No." They don't understand it, they tell me. I tell them that it is much easier to make money in a bull market than in a bear market, but no dice. They have no interest.
Most fund managers do not own gold. And those that do, own a very small portion in their fund. Except for some hedge funds and a few vocal gold bulls, the professional money manager is not there. Nor is the retail investor. Despite gold pushing all-time highs, and despite what the gold bears might say, investors are not All In on gold.
From Barron's
GOLD'S NEXT ATTEMPT AT breaking through its previous all-time high is likely to be successful.
That at least is the conclusion reached by a contrarian analysis of gold market sentiment. The gold timers are remarkably subdued right now, even as gold bullion trades within shouting distance of that previous high.
This suggests to contrarians that there's a robust wall of worry out there for a gold-bull market to climb.
Consider the average recommended gold-market exposure among a subset of short-term market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). As of the middle of last week, HGNSI stood at 30.5%, which means that these timers on average are recommending that their clients have some 70% of their gold-oriented portfolios in cash.
To put this high-cash position in context, consider that the HGNSI in January stood at 60.9%, double where it is now. At the time, gold bullion was trading around $1,130 an ounce.
In midday trading Monday, gold was trading at around $1,240 an ounce, near its all-time high.
In other words, the net effect of the gold market's gyrations over the last six months has been to add more than a hundred dollars to gold's price while simultaneously leading the average gold timer to cut his recommended gold-market exposure in half.
It's rare to see such a marked divergence, since the almost universal tendency is for market timers to become more bullish as the market rises and more bearish as it declines.
The current sentiment situation is therefore quite different from what prevailed in early December, the last time I devoted a Barrons.com column to a contrarian analysis of gold's prospects. On that occasion, the HGNSI stood at 68%, even higher than where it was in early January.
Contrarians therefore were not surprised that gold struggled over the next couple of months. At its February low, in fact, bullion was 12% lower than where it stood when the HGNSI was as high as 68%.
To put the gold timers' sour mood into perspective, imagine how bullish and exuberant stock market timers would be if the Dow Jones Industrial Average were trading within shouting distance of its all-time high above 14,000 -- four thousand points higher than where it is now. To match gold timers' current mood, though, the stock market timers in that otherwise happy scenario would have to have the bulk of their equity portfolios in cash.
Hard to imagine that happening, isn't it?
Also, witness Robert Prechter
I have no idea where Prechter gets his data showing that gold psychology was "98 percent bullish" given the skepticism I see. Gold tends to be owned by people who see it as a religion, not as an investment. We are nowhere near the euphoria seen in the Housing or the Tech Bubbles.
Prechter said at the Reuters Investment Outlook Summit in New York that recent readings of gold market psychology showed a 98 percent bullishness in the metal, the highest ever recorded for any physical commodity.
He said, however, that technical momentum was stalling for gold as the rate of increase had peaked in 2006, and that each subsequent rally since then has risen at a slower rate.
"That is not a guarantee of change but a sign that one is likely."
In January, he had forecast that gold could drop at least 40 percent from its peak value because of deflation and over-ownership.
Asked if Prechter still expected gold to correct 40 percent, he said that extremes in technical indicators still "leave gold vulnerable to that large of a decline."
"I still feel that gold is not going to the moon here. It's not a market that you want to be long, just as you didn't want to be long stock in the first quarter."
Nor do I understand Prechter's comment about momentum slowing. In fact, gold has taken only eight months to hit new highs compared to ~18 months after the peaks in 2006 and 2008.
I see this chart as being very bullish. Prechter, though, has a poor record as a near and intermediate term prognosticator. Of the 58 "investment gurus" tracked by the CXO Advisory Group, Prechter ranked 57th, getting it wrong three quarters of the time. I noted a week ago that relative to other bubbles, gold has some ways to go. David Rosenberg of Gluskin Sheff notes the same thing.
(HT: The Big Picture) What worries me is that gold has been going up recently because of fear. In this 9 year gold bull market, liquidity and currency debasement have been the primary drivers of the price of gold. Both are long-term structural issues that are difficult to reverse. Fear is different. Fear can change on a dime. However, I will not quibble with the market. It appears to me that gold wants to go higher. Who am I to argue? I am very long gold.
First, full disclosure. I am talking my book. I own a lot of gold. Since I have a large position, I am biased. Always consider the position of the proponent when assessing the validity of the argument, me included.
Also be extremely aware that I may change my mind tomorrow and not tell you. I own both gold ETFs and call options on gold ETFs. If I feel that I am wrong or gold is rolling over, I may blow out my entire position. Owning call options implies an element of timing. I am not dogmatic and will sell everything if I think the market is turning against me.
Brett Arends had two articles in the Wall Street Journal last week. The first article was on why gold probably has some ways to go. I agree.
First, the recent rise [in gold] is deceptive. Yes, gold has risen from around $250 an ounce to $1,200. But that rise started at very depressed levels. Gold had been falling in price for two decades. In 2000-01, it was at the bottom of a very deep bear market. It had touched historic lows compared to consumer prices or other assets like shares. A lot of the past decade's boom has simply seen it recover toward longer-term averages.
Second, before we assume the gold bubble has hit its peak, let's see how it compares with the last two bubbles—the tech mania of the 1990s and the housing bubble that peaked in 2005-06.
The chart is below, and it's both an eye-opener and a spine-tingler.
It compares the rise in gold today with the rise of the Nasdaq in the 1990s and the Dow Jones index of home-building stocks in the 10 years leading up to 2005-06.
They look uncannily similar to me.
So far gold has followed the same path as the previous two bubbles. And if it continues along the same trajectory—a big if—gold today is only where the Nasdaq was in 1998 and housing in 2003.
In other words, just before those markets went into orbit.
Maybe the smart money is out of gold today. But how easily we forget that the smart money got out of these past bubbles way too early. The really smart money knows you make the most money in a bubble right at the end, when it goes manic.
In fact, the rise in gold looks fairly measured. This is a logarithmic graph of the price of gold since 2001. Gold has risen at a fairly steady rate in the nine-year bull market thus far.
The top of a bull market / bubble is usually marked by a final surge that explodes higher. There have been times of frothiness in the gold bull market, but after mild corrections, the price has resumed it's upward trajectory.
Compare gold to the Nasdaq, which exploded higher in 1999 and topped in 2000. This is a logarithmic of the Nasdaq from 1998 to the top in 2000. The slope of the final move is steeper than the previous increases in the index.
If Arends's chart is a rough approximation of where gold is headed, it will top out at $2500 to $3000 within a few years. On some measures of inflation, the real price of gold topped out around $2300 nearly 30 years, so a $2500-$3000 price target is not unrealistic.
Arends's second article was more critical of gold.
In Part One of this series, when I argued that gold might be about to go vertical, I made a whole bunch of new friends among the gold bugs.
And now I'm going to lose them all.
That's because even though I think gold might be about to take off, I don't recommend you rush out and put all your money into gold bars or exchange-traded funds that hold bullion.
And this is for one simple reason: At some levels, gold, as an investment, is absolutely ridiculous.
Now I can respect someone who says that they will not invest in something they do not understand. I stay away from biotechnology like the plague because I am utterly clueless about biotech. I also agree that at some point, gold as an investment will become absolutely ridiculous. There will be a time when you will want to be far, far away from gold.
However, I disagree with Arends's premise regarding why gold is ridiculous as an investment. He makes a mistake, I believe, many people make, including Warren Buffett, whom Arends quotes.
Warren Buffett put it well. "Gold gets dug out of the ground in Africa, or someplace," he said. "Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. [Emphasis added] Anyone watching from Mars would be scratching their head."
Now, it is a rare occasion when I disagree with the world's greatest investor and richest man, but Buffett is making a fundamental mistake regarding utility.
Gold bears often argue that gold has no fundamental use or intrinsic value. This is what Buffett implies in his argument - "We don't use it. We just pay people to guard it. What good is that?"
Well, let us look at a product of one of Buffett's most famous investments, Coca-Cola.
Buffett made a fortune in Coke. When he bought the stock decades ago, Buffett realized that Coca-Cola was a powerful and ubiquitous brand that had tremendous global appeal and, at the time, significant cost cutting opportunities. Plus, the stock was dirt cheap. Coke was the perfect Buffett investment.
But what is Coca-Cola? It is flavored sugar-water. It has no nutritional value. It makes you fat and it gives you diabetes. It is loaded with caffeine. Coke is bad for you. It is unhealthy. What "intrinsic value" does Coke have?
Turns out, it has intrinsic value because it tastes good. People like it. From a health standpoint, nobody should ever drink a drop of Coca-Cola, but that does not matter. We want it. It appeals to people's tastes.
Fact is, most of what we consume is related to taste. We do not need to own a big house or an expensive car or nice clothes. We choose to do so. Most stuff people buy is not necessary. We buy most stuff because we like it. We do not need to eat a restaurant. We can make things at home. We do not need to eat steak or drink wine. We can find nourishment in cheaper foods. Instead, we do so because we want to, because eating steak and drinking wine appeals to us. We like it.
Most gold is consumed as jewelry. Jewelry has utility because it is shiny and pretty and appeals to our tastes. What intrinsic value does jewelry have other than we like it? How is that any different from liking a good steak, a fine wine, a nice suit or a Coca-Cola?
This is all utility. Utility is the satisfaction something gives us. We don't need to buy a steak, we can eat lentils and rice instead. We don't need to end the day with a nice merlot, we can drink water. We don't need to dress in nice clothes, cheap suits from Sears will do. We don't need to drink Coke since we will probably live longer if we don't. But eating steak, drinking wine, wearing nice clothes and craving Coke all gives us utility. And we get the same utility from owning gold.
"Ah, Toro," you might be saying, "you are talking about jewelry, not gold as an investment. What utility does gold as an investment give us?" It gives us the same utility that property insurance or a home security system gives us - peace of mind. It is money to protect us from the debasement of fiat currencies by governments. And the debasement of fiat currencies has been occurring at an alarming pace for the past decade.
In his book, Money Mischief, Milton Friedman describes a society in the south Pacific whose money was giant limestone rocks at the bottom of the ocean that nobody had ever seen. It did not matter that nobody had possession of or even had seen these rocks. What mattered was the value assigned to those rocks. The inhabitants used those unseen rocks as a medium of exchange and a store of value. The submerged rocks were money because people believed they were money. This unseen money had value, and thus utility, to Micronesians.
Gold is money because people believe it is money. There is no doubt that gold is money, given the recent scramble to buy gold in Europe because of the Greek debt crisis.
Thus gold, indeed, does provide utility to its owners. Gold is shiny and pretty and it appeals to our tastes. And it is money.
One final word - gold is in a bull market. There are very few assets in the world today that are in a bull market. Gold is one of them.
If you don't get it, fine, don't buy gold. You should never invest in anything you don't understand anyways.
But otherwise, don't overthink it. Gold is in a bull market. And it is much easier to make money in a bull market than in a bear market.
Gold was hammered on Friday as investors stampeded out of a crowded trade, me included. The impetus for the sharp decline was the stronger than expected jobs report, and a fear that the Fed would start raising interest rates and withdrawing quantitative easing sooner than expected.
But does higher interest rates automatically mean lower gold prices? The answer eventually is "yes" but not necessarily immediately. In the last peak during the 1979-80 run-up, yields on the 10-year T-bond rose from 9% to 11% as gold rose from $200 to $850.
This does not mean that gold is impervious to rising interest rates in the short-term. Gold may have topped. However, it does not mean that gold has topped.
Remember, tech stocks kept rising when interest rates rose in the late 1990s, and housing prices went up this decade as the Fed tightened. Asset bubbles usually do not pop at the beginning of the tightening cycle. Asset bubble usually pop near the end of the tightening cycle.
Again, that does not mean that gold has not popped. Gold may have. These are not usual times. The amount of monetary and fiscal stimulus in the economy is unlike anything we have experienced before, which is almost certainly changing the dynamics of asset markets. However, do not assume that simply because interest rates may start rising soon, the gold run is over.
