Saying yesterday that gold looks terrible led to some thoughtful comments and emails (which are always appreciated).
Given that, it makes sense to provide some clarification:
- This was more of a trading view than an investment view.
- From an investment perspective, gold may still be “ok” — but the rationale looks shaky.
- Bullish arguments based on past conditions are suspect — because conditions are changing (with the charts reflecting that change).
- Gold may have witnessed a blow-off acceleration in second half 2011 (see chart below).
So ok – let’s roll up our sleeves on this again…
As some of you have pointed out, “it’s all about time frame.” There is a difference between a short-to-medium term time frame — that which applies in trading — and one that lasts for years. Even still, though, we find the investment case questionable. (More on that in a moment.)
Technically speaking, right now gold is in “no man’s land” (though oversold gold miners may be ripe for a tradeable bounce).
The daily chart for gold is in a shortable downtrend, with GLD threatening to submerge below its 200 day EMA (exponential moving average). That is not a condemnation or a guarantee of doom, but a warning sign.
What about the investment case — and the longer term chart?
Let’s take a look at GLD weekly:
Without getting into chart esoterics, it is easy to see the steady, stair-step bull run in gold has stalled out — and possibly climaxed after the sharp acceleration in 2011.
Following that acceleration, we have seen a stair-step process lower and a possible double-top, leaving gold in the middle of nowhere.
From a trading perspective, gold looks terrible because there is no clear read on it now. This goes for the fundamentals too.
Revisiting the investment case
Let’s focus a little more on why some folks are extremely long-term bullish on gold, and what has set the stage so far:
Gold has been in a secular uptrend for a decade. Many arguments for gold as a long-term investment relate to the yellow metal’s strong run since 2002.
One could argue that gold’s great run is firmly tied in to central bank trends. Gold “woke up” around the time Alan Greenspan, aka The Maestro, decided to cure the overhang of the dot com bubble by inflating yet another bubble, lowering interest rates to 1% and leaving them there for nearly a year.
In addition to Greenspan’s folly — which Bernanke continued — the 2000’s saw the “conundrum” of falling long-term U.S. interest rates in the midst of a boom, as Chinese manufacturers and Middle East oil exporters took on a “vendor finance” relationship with the United States:
- Americans bought “stuff” and oil on credit
- China and the Middle East absorbed large amounts of dollars
- Surplus dollars recycled back into U.S. Treasurys, keeping rates low
- Low rates perpetuated the housing boom / leverage cycle
As a general backdrop to all this, emerging markets boomed too, and piled up their dollar-denominated savings, even as the developed West gorged on leverage and debt.
Thus was born the famous “global savings glut” — Bernanke’s way of blaming the world’s savers — a product of aggressive Western spending and a dollar surplus feedback loop, resulting in artificially suppressed long-term rates to go with Greenspan’s suppressed short-term rates.
Voila: Conditions for a cheap money boom that were also extremely supportive of gold.
The whole of the 2000’s as a decade, in fact, was characterized by paper asset inflation (not to mention hard asset inflation) and broad currency debasement, driven by easy monetary policy, aggressive feedback loops and exacerbating macro factors. This was a goldilocks environment for gold.
But how long do such goldilocks environments prevail? All good things come to an end… and most bad things too. Even as the long-term charts have gone from “unquestionable uptrend” to “question mark,” so too have the macro drivers for gold’s bull run become a giant unknown.
To put it another way: As traders who respect price, the charts alone are enough to make us wary of gold. But the fundamentals are a concern too because the conditions that supported gold’s rise may no longer exist. Consider:
- For most of the 2000’s, central banks (primarily the Fed) were openly accommodative. Now they are talking about withdrawal.
- For most of the 2000’s, the U.S. “vendor finance” relationship with China and the Middle East was intact. That relationship could now be ending.
- For most of the 2000’s — and actually the past few decades — U.S. interest rates have been falling (long bond bull market). That could now be ending.
- Gold’s potential “climax run” in 2011 — reference the weekly chart above — may have also coincided with a coordinated crescendo of global central bank intervention. If the global economy is truly recovering, this is almost certainly the case.
Bullish gold and bearish long bonds? Really?
Here is another funny thing: Many of those who are staunch long-term bulls on gold, are also anticipating a ferocious bear market in U.S. treasury bonds. They are rubbing their hands and waiting for the collapse of the long bond market, at which point U.S. interest rates will be forced to sharply rise.
We too like the long bond short trade (and have said as much repeatedly). That is some price action we can get behind!
But can you really expect sharply rising interest rates and rising gold simultaneously? To borrow a British slang phrase, “not bloody likely.” Rising interest rates (and tanking bonds) make sense to us in the context of three scenarios:
- An increasing faith in economic recovery, leading to a “reverse flight to safety” out of bonds and into equities
- A Federal Reserve decision to withdraw support, allowing rates to rise and stocks to correct (possibly sharply), as the economy is allowed to “stand on its own two feet” again
- A gradual withdrawal of U.S. treasury buying support from China, Japan et al
The thing is, none of these scenarios are bullish for gold. Why? Because they all imply a monetary tightening bias of some kind, and/or a renewed focus on economic recovery and growth assets (stuff with yield and participation capability in a moderate inflation growth environment).
But surely it will all end in tears… won’t it?
“Hold on, hold on, hold on,” many of you say. “You have to understand that central banks are gonna fail… and monetary disaster awaits us….”
We are very (very) familiar with all the long-term arguments for being a secular bull on gold, having articulated many of them personally:
Monetary velocity problems… the likelihood of a new “Minsky moment” and a worse crisis than 2008 following on the heels of folly… the inability of the central banks to withdraw liquidity fast enough when recovery actually happens… the likelihood of another global slowdown and deflationary spiral leading to QE3, 4, 5, and so on.
And to be clear, we fully accept that one of those scenarios could come to pass!
- The world really could see another “Minsky moment” (go here for definition).
- We really could see another global recession / deflation spiral that spurs QE to the Nth power (3, 4, 5 etc).
But are either of those really a sure thing, or anywhere close to a sure thing?
And what if the price of gold falls $500 an ounce BEFORE one of those things happens?
Will all those who are still committed gold bulls right now, in the $1600s, still be gold bulls if we get a touchback to triple digits ($999)? Are ya sure?
And what happens if the economic recovery is real… or, at the very least, a long-lasting enough mirage, posing as real, for central banks to meaningfully step back, allowing for a rising U.S. interest rate / strengthening $USD trend?
Gold gets hammered (or bled out) in such circumstances to a painful degree… and such could last a long time (Months? Quarters? A year or more?) even if the monetary macro pessimists are proven right in the end.
What lets us sleep at night
As an example of the type of thinking that runs deeply counter to ours, there is a Seeking Alpha article titled “Why I Sleep Better With 50% of My Money in Precious Metals.”
Wow. That seems crazy to us because there are multiple plausible scenarios in which gold declines by a substantial amount — $500 per ounce or more — over the next 12 to 18 months. (This possibility is heightened, as we mentioned, by the extremely heavy retail weighting in GLD.)
As traders, the thing that lets us “sleep at night” is risk management and the use of stop losses. I don’t know about you, but if I had half my net worth in something that could quite plausibly lose 30% of its value or more at a statistically non-trivial rate of probability, I would not be sleeping well at all!
This is not a PREDICTION that gold will fall dramatically, by the way, but rather a recognition that 1) it most definitely could happen; 2) the charts are a warning sign (muddled at best); 3) the 2011 price acceleration runup may have been exhaustion, and 4) even if gold is destined to climb the mountain to $5,000 an ounce or whatever, there may well be a “Death Valley” between here and there.
Happy to be long — if the price and the macro act right
As a final note, as mentioned we are not gold permabears. (We are not perma anything — and never will be.) Right now the gold charts are a muddled mess, and the macro environment looks distinctly disfavorable.
If both those conditions change, however — if the charts again look favorable and the macro environment shifts in a clear and powerful way — then we will have no problem whatsoever buying gold again.
For the moment, though, gold looks “terrible” in the sense of being a directionless asset (with a near-term bearish bias) that has non-trivial risk of falling substantially in price, even if longer term monetary policy disaster scenarios come true with a lag.
Flexibility is a virtue… as is the ability to hold any thesis at arm’s length, rather than become married to it by dint of the demands of one’s investment style.
Clear as mud? Comments as always welcome…