Friday, September 4, 2009 5 comments ++[ CLICK TO COMMENT ]++

Gold closes in on $1000...Fifth time lucky?

Gold passes $1000...bubble forming? was the title of one of my posts from earlier this year. Admittedly, the title was a bit too extreme and it's probably a bit premature to start calling for a bubble. I still remain bearish (although I would not short gold right now) and anyone interested can read some of my reasons in my original post back in February. In any case, this post is about the present.

The story of the week for me is gold's attempt to break past US$1000. Fifth time lucky? Remains to be seen.



The above chart plots the gold ETF, GLD, which is very close to 1/10th the price of gold price. In the last two years, there has been five occasions when gold has been within 5% of $1000.

The interesting thing this time around is how gold rallied strongly even though the US dollar didn't decline materially (it was essentially flat this week.) The stock market was also largely flat for the week. In the past, gold has has high correlation with the stock market. Long time readers may recall this is one reason I turned bearish on gold mining stocks. Gold bullion is less correlated than the miners but, nevertheless, it's not a good sight to see that. From the 1970's to 2000's, gold and gold mining stocks have had low to slightly negative correlation with the broad market. This hasn't been the case in the last 5 years or so. To quote Gary Shilling in a different context, it's all one trade.

If gold moves independently of the US$ or the stock market, it's probably favourable for gold owners. It likely means that gold has gone back to its traditional role as a lowly-correlated or uncorrelated asset.

As for me, I'm still maintaining my prior stance for now. To recap, I believe gold is a poor investment right now. This is mainly from a contrarian point of view. The Dow-to-gold ratio is almost near an extreme and it appears that there is less upside than downside for gold, relative to stocks. However, shorting gold is too risky right now since there is a risk of a hyperinflation threat. I don't believe we will end up with hyperinflation—if we do, it will be a purposeful act possibly due to war—but the masses, just like with oil last year, may bid up gold. In other words, we may see a spectacular blow-off stage. If you are contemplating shorting, that is the point to short. (You can probably short gold if you believe in strong deflation as well, but the upside is probably low. If you are a believer in strong deflation then shorting stocks or real estate or something like that is better. However, the behavious of gold under deflation is hard to predict due to a whole hoard of factors (psychology, government policy, etc.) For an interesting discussion about gold under deflation, you may want to check out this blog entry by Mike Shedlock.)

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5 Response to Gold closes in on $1000...Fifth time lucky?

Daniel M. Ryan
September 5, 2009 at 1:47 AM

I think your bubble-sniffing apparatus has zeroed in on something. Gold is one of the few asset classes that hasn't had a bubble in a generation, and (as I've said before) inflation is beginning to look like an acceptable price to pay to avoid financial collapse.

I'm not trying to convert you to the inflationist viewpoint. In fact, it'll be a good time to be deflation-oriented once inflation becomes a serious problem. Deflationists were formally wrong in 1981, but at least one of their calls (long T-bonds) was spectacularly right. Inflationists (reflationists) who didn't take Volcker seriously, in addition to being wrong themselves, wer portfolio-killers.

True fact: there was a 1981 book entitled Is Inflation Ending: Are Your Ready? One of its co-authors was A. Gary Shilling.    

Guest
September 7, 2009 at 2:13 PM

Why not short Gold as a contrarian, it is hard to find an opposing view to it hitting $1000.

Why not short it with a stop at 1005 using a minute part of your portfolio because if it doesnt break $1000 the exit will not be big enough and we could see it at below  $600

This might sound like a crackpot theory to some but it is contrarian.

Sivaram
September 7, 2009 at 4:45 PM

I didn't realize Shilling wrote such a book. Interesting. I knew he was right with bullish call on long bonds but didn't realize that he timing was also quite good...

Sivaram
September 7, 2009 at 4:51 PM

I think you touch on an important issue for contrarians so I hope you don't mind me answering this question in a stand-alone post...

Daniel M. Ryan
September 7, 2009 at 8:56 PM

I never read it, but I did read of it although I can't remember where. It might have been mentioned by a thoughtful goldbug to make the reader aware of the opposite side of the infaltion/deflation debate.

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