The surprise of the year to me is... gold

A lot of people are surprised by the green shoots... or the collapse in financials earlier in the year... or the deteriorating economic picture... or the humongous fiscal deficits...

But for me, the biggest story of the year is gold—or the lack of signicant moves in any direction. The following 2 year weekly chart of the gold ETF, GLD, shows how gold hasn't gone anywhere in 2 years (GLD will slightly underperform gold due to transaction costs and ETF management fees.)



In 2009, gold is probably up around 7% so it's not bad by any means. Nevertheless, given the talk of hyperinflation and the almost certain inflation that is around the corner, at least if the inflationists are to be believed, one would have thought gold would be up strongly. I was personally expecting gold to hit at least $1500, at which point, I was thinking of shorting it. Instead, gold has had difficulties breaking through the $1000 price level.

I do not believe that the futures market is a very good predictor but it is worth looking at what the market is pricing in currently:



The futures market looks like it is pricing in largely flat gold prices until 2011 and an increase, a little over, 10% by 2014. This is consistent with my mild-deflation/low-inflation view* and the gold futures market has similar expectations as the TIPS bond market. But I do not give much credence to the futures market (for instance, when oil was really high, it was projecting really high oil prices for many years; conversely, when oil prices was really low, it was projecting low prices for years into the future.)

It's worth keeping an eye on gold to see what happens in the latter part of the year. If deflation takes hold, I expect gold to sell off sharply (similar to late last year when it collapsed along with all other assets.) If gold rallies sharply, it's possible inflation may be a real threat.


(* My opinion is not very strong and I haven't invested directionally either towards inflation or deflation...yet. I lean more towards deflation but am more neutral than anything. Don't blindly follow anything I say.)

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5 Response to The surprise of the year to me is... gold

Daniel M. Ryan
July 7, 2009 at 12:15 AM

I've been watching the gold market for some time myself, and I have to admit to being fooled often. I believe the hyperinflation expectation kept gold from plunging in '08, but the market's at the "show me the [depreciating] money" stage. Also, the U.S dollar isn't being creamed on the forex market as of now.

Given recent money supply growth, and the persistence of the Fed beyond the usual short-term money growth spurt, I'd suggest 2010 as the year for gold. The futures market may be a year behind on this one.  

Sivaram
July 7, 2009 at 11:13 AM

Does this mean you are in the inflation camp?

I lean more towards deflation so am bearish on gold. So what is happening is not a huge surprise. If we get deflation, even a little bit, US$ should strengthen (like last year). But it remains to be seen if we get inflation or deflation. The consensus is on your side (but as a contrarian, I don't want the consensus on my side :) )

I used to be bullish on gold a few years ago (in fact, my best performing investment is some junior gold mining warrant) but became bearish a few years ago. My big problem with gold at that time was that gold was highly correlated with the broad market. I was thinking that if the market ever fell, gold would fall too. I was partly wrong and gold actually rose after I turned bearish. But it hasn't done too well since. With the whole financial system on the verge of collapse, gold went nowhere. In fact, it collapsed 30% from the peak, along with all the other assets late last year. It did presever its value over the last 2 years but it underperformed cash/govt bonds/US$/Yen.

If the market sells off, I think gold will decline as well. But it depends on the underlying reasons. Gold will rally if we get a inflationary threats but I don't see that as being likely any time soon.

Sivaram
July 7, 2009 at 11:16 AM

Does this mean you are in the inflation camp?  
 
I lean more towards deflation so am bearish on gold. So what is happening is not a huge surprise. If we get deflation, even a little bit, USDoes this mean you are in the inflation camp? I lean more towards deflation so am bearish on gold. So what is happening is not a huge surprise. If we get deflation, even a little bit, US$ should strengthen (like last year). But it remains to be seen if we get inflation or deflation. The consensus is on your side (but as a contrarian, I don't want the consensus on my side :) )


I used to be bullish on gold a few years ago (in fact, my best performing investment is some junior gold mining warrant) but became bearish a few years ago. My big problem with gold at that time was that gold was highly correlated with the broad market. I was thinking that if the market ever fell, gold would fall too. I was partly wrong and gold actually rose after I turned bearish. But it hasn't done too well since. With the whole financial system on the verge of collapse, gold went nowhere. In fact, it collapsed 30% from the peak, along with all the other assets late last year. It did presever its value over the last 2 years but it underperformed cash/govt bonds/US$/Yen. If the market sells off, I think gold will decline as well. But it depends on the underlying reasons. Gold will rally if we get a inflationary threats but I don't see that as being likely any time soon.

Daniel M. Ryan
July 7, 2009 at 5:44 PM

I am in the inflationist camp, although the recent enthusiasm made me a little skittish. Congratulations on your warrant pick.
Actually, gold may be due for a bubble if inflation's going to be as bad as I and other infllationists think. With the exception of T-bonds, gold was the only asset class with a one-year gain at the end of 2008. A similar standing convinced people that real estate was "a sure thing" several years ago.
I'm not too enthusiastic about such a prospect, though. Bubbles are notorious for the speculator's three-step: $1000 -> $100,000 -> $0, or worse. They're certainly not the place for value investors.

Sivaram
July 7, 2009 at 6:45 PM

Sorry about my messed up post... JS-Kit messed it up :(

Do you own gold? Is that gold or gold stocks? Or both.


"Actually, gold may be due for a bubble if inflation's going to be as bad as I and other infllationists think. With the exception of T-bonds, gold was the only asset class with a one-year gain at the end of 2008. A similar standing convinced people that real estate was "a sure thing" several years ago. "

Yeah, I think it is vulnerable to a spike. If we get a panic over the solvency of USA or the US$, it will spike. However, I think it will underperform, say, US stocks over the next decade.

Even if gold enters a bubble stage, it won't be big. It's a niche market--the market cap of every single gold mining company in the world is less than what Microsofot or ExxonMobil is worth--so it will probably see a quick decline.


"They're certainly not the place for value investors."

Yeah... I'm not a value investor (am somewhat macro-oriented) so I do consider making a macro bet. You have to get the timing right or else it could be a disaster. The problem with gold, obviously, is that you can't determine its intrinsic value. EVen then, some value strategists like Jim Grant and Jean-Marie Eveillard do buy gold once in a while--but mostly as insurance.


Anyway, good luck with your investments...

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