Still bearish on the yellow metal

24 Jan 2009 9: 26 am | Filed under: Shorts, commodities, crash, deflation, depression, gold, short selling, technicals

As many readers know, I have been bearish on gold lately. I have been buying puts on GLD and GDX and bought more yesterday, though I do have a big chunk of assets in bullion (20x more than in puts). My bullion is not for sale, but I suspect that the reality of deflation and its likely duration has yet to fully sink in, and that we are due for a demoralizing event in the gold market.

Gold is not fully treated as money at the moment, though fiat currencies don’t satisfy all of the criteria for money either. Only precious metals can fully satisfy them, when governments allow.

So gold is not really money now, since its liquidity is limited, but it is a long-term store of value that outlasts currencies and governments. This is the key point: from the perspective of a large player who can afford warehouse costs, other metals or commodities can also serve as a store of value and hedge against fiscal calamity. Copper and cotton and rice will never go to zero either.

Almost all other commodities are down by huge percentages, though gold hangs on. It makes sense for gold to outperform the others, since it is more liquid and portable and people naturally prefer it during a crisis, but the premium seems way too high.

Once this panic phase of the depression is over, and a general funk and low-velocity environment settles in, with the dollar and other currencies having survived to the surprise of so many gold owners, the metal could be again seen as dead weight and fall as people still need plain old folding money to pay their bills, debts and taxes.

That is how I see things. Only time will tell if I am right.

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33 Responses to “Still bearish on the yellow metal”

mac
January 24th, 2009 at 9:52 am

I am bearish on gold in the short-term (0 - 12 months), though we could see it pop to $950 - $1000 again before a decline to $700. It seems to have a little momentum right now.

You make a great point about people needing to pay their bills, and this could have an impact in coming months, as people sell of some of their hoarded precious metals to make ends meet. I also have this feeling that we might see a short-term bounce in the DJIA and S&P — and if this happens, paper traders of COMEX gold/silver futures might shift back into the equities markets to make up some of last year’s losses. I think there are a number of other factors that may come into play in the near future, all of which may take gold down a notch or two.

Long-term, though, I feel like we are still in a period of ‘correction’, and we will see more lows in the equities markets, an eventual decline in the US dollar, a blow up of commercial real estate and credit cards, and some say even a treasury bubble burst. Add a geo-political event like an attack on Iran and these factors, i think, may contribute to a long-term bullish outlook for gold, say in 2010-2012.

Just my huble opinion.

Great post.

Thanks.

Mac
UndCvr Jellyfish
January 24th, 2009 at 10:21 am

Mish’s article on Nov 21st 08 contradicts your sentiment. It was written when the price of gold was about $740.

Most importantly he mentioned something about
‘ Finally, gold itself is now free to rise in deflation given its true role as money, even as those in gold for the wrong reason (as an inflation hedge), bail.

Would you care to comment on that ? His full article is below.

http://globaleconomicanalysis.blogspot.com/2008/11/i-like-gold-here.html
mac
January 24th, 2009 at 11:00 am

my personal opionion: it can go either way! haha…

So, I say: keep acquiring physical whether it is up or down. (I’m taking this recommendation directly from a recent Jim Rogers interview)

my belief is, that eventually, it’s going a lot higher than it is today. Timing the ‘up’, though, is a challenge.

i have given up on betting short-term moves and am going with the overall trend, however, i hope for some downward pressure in the short-term so i can pick it up a bit cheaper than it is now.

mac
Bridget
January 24th, 2009 at 11:03 am

So, I’m stuck in a 401K with no way out. In addition to assorted domestic and international equity mutual funds, I can choose from several fixed income pools all stuffed to the gills with mortgage backed securities and other dreck. There is no cash alternative, much less a treasury backed cash alternative.

I’m toying with the notion of placing it all in the S&P 500 mutual fund and then buying long term LEAPS puts in my IRA as a hedge. I know you are a fan of LEAPS, so I’d really appreciate your comments on counter party risk.
Mike
January 24th, 2009 at 11:10 am

I am almost always in agreement with Mish on the markets. He has a very good nose for pricing sentiments. I admit it is lonely here at the moment, but I just can’t see gold holding up like this forever as everything else falls in relation to currencies (save for corrective bounces).

Since 2007, like Mish, I have believed that gold would fall in the early stages of the crash as everyone de-levered. Mish seems to think that that stage is over for gold, with the froth having been blown off the market. I don’t think we have fallen hard enough yet, and that there is another hard leg down.

I just think that there is still too much faith in gold as the end all and be all of crash protection. So many people who owned it believing that we would be in hyperinflation by now are still hanging on.

Almost nobody understands both of the following two points:

#1) This is a depression greater than the last one. Most still are in denial about that.

#2) $50 trillion in private debt is imploding so quickly that the Fed has no chance of reflating until it all defaults and asset prices bottom. The more they prop up the banks, the longer that process will take. We are talking years and years, during which people and firms will be going broke and desperate for everyday money, not gold.

I think survivors of the crash will find they have plenty of time to accumulate gold and all manner of hard assets at fire sale prices.
Gary
January 24th, 2009 at 11:18 am

I agree with your analysis and am hoping for another opportunity to buy gold at a lower price. With the dollar strengthening as it has recently, gold must be setting record prices in other countries. Is fear of monetary collapse in England and Europe becoming widespread? How bad is it over there? The current environment reminds me of the sentiment around the times when Bear Stearn and Lehman Brothers went down. If this situation plays out in the same way, gold should drop in price when things calm down.
Mike
January 24th, 2009 at 11:23 am

Hi Bridget. That is a tough situation. Can you buy options in your IRA? I would be very surprised if you could.

Even if possible, LEAPS are not a perfect hedge, since there is a risk that as things deteriorate further, the integrity of the OCC is threatened. I have no more insight into that risk than I did before the crash — I do assume though that as long as the big banks get unlimited handouts they will use some of that cash to support the clearinghouse, of which they are members.

I guess you could spread the risk — some in the junky debt funds, some in a stock fund, and buy options either in an IRA or out (it doesn’t take much capital to hedge with deep out of the money options).

Option premiums are pretty high at the moment — I have actually closed a lot of pre-crash positions in the last few days: MSFT, UNP, BNI, and HOG, among others. The next time we go to new lows, I will sell almost all of my puts and wait in cash before shorting the next bounce.
Mike
January 24th, 2009 at 11:28 am

Gary — In Zurich, things are not so bad. The job market is still ok from what I can tell, and the mood is not glum — the ski slopes and restaurants are still doing well. But these are the Swiss, and they all have savings. Things change slowly here.

The UK must be a nightmare, the Ukraine is on the very of total collapse, and the Club Med countries would like to break from the Euro and print away in Pesos, Drachmas and Lira.
Bridget
January 24th, 2009 at 11:33 am

Thanks for your comments, Mike. I can buy options in my IRA, but shorting is prohibited. Another option I’m considering is putting the 401K in a junky government sponsored debt fund and using a non retirement account to short an ETF I found called MBS, but that will consume considerably more of my capital than the LEAPS puts.

ARGHHHH!!!!!
GG
January 24th, 2009 at 12:03 pm

Sorry Mike, but the “deflation” view you are propounding has now become mainstream. I’m gonna have to take the other side of the bet. The fact of the matter is that no fiat currency has ever died (or can IMHO) of deflation and ALL fiat currencies in the world have died - all of them. No matter what the mechanism and whether it’s obvious to anyone or not - fiat currencies are gonna die a hyperinflationary death - and sooner than most people expect (Mish thinks its gonna be more than 10 years). No wage price spiral is necessary, no job creation is required, no “recovery” is needed, no inflationary “expectations” BS, etc. The hyperinflationary event will be government triggered, i.e., one of the MAJOR countries’ banking system going kaput or alternately the government itself going bankrupt as a result of “backstopping” the financial system. Investors are gonna lose confidence in an instant. Looks like UK might just start the party.
Mike
January 24th, 2009 at 12:08 pm

Bridget — I would advise against inverse ETFs as a hedge. They are for hard-core technical traders only:

http://sovereignspeculator.com/2008/08/08/inverse-etfs-vs-leaps-puts/
Mike
January 24th, 2009 at 12:11 pm

GG — You never know. That’s why I own a bunch of gold. I think that kind of thing could happen within 5 years. I have never seen Mish put a time frame on things — people are always trying to get him to nail it down, but he wisely refuses. Timing is always the hardest thing.
GG
January 24th, 2009 at 12:17 pm

I happen to be in possession of an email from Mish that has him putting a timeframe of “a decade or more” on the hyperinflation.
GG
January 24th, 2009 at 12:21 pm

Gotcha!
GG
January 24th, 2009 at 1:13 pm

“…when governments allow”.

I think that despotic..er..democratic governments such as the US Govt. are going be so helpless during this depression/disintegration that the emperor is gonna be naked for all to see. People are going to lose any faith they still have in it - and I must say that western countries have a lot more of it than the eastern ones which is why the adjustment is going to be tougher there. The question of governments “allowing” someone to do something is going to become moot. HUGE black markets will develop as this will be the only way people will be able to survive. Governments will be weakened as their biggest source of power disappears - the power to issue currency as less and less people accept it for payment and/or dishoard it as soon as they receive it. Yes the government has guns, but people will respond in a fight or flight fashion. Either they will flee from despotically ruled nations (such as the USA) to freer ones or they will fight it - just like the people in british colonies. It will be a literally battle for survival for the people.

This weakening argument only applies to governments who don’t allow a free market to function - including that for the currency. Governments which embrace a REAL free market philosophy will see their nations prosper - just like the US did when it was actually free. The “allow” argument is moot here as well.
GG
January 24th, 2009 at 1:21 pm

Also, I am not sure if the “guns” are gonna be as effective as the enforcers of govt. regulations will themselves be starving and convinced to look the other way for some “consideration”. You should definitely look at how economies are operating in countries such as India. The black market there is essentially bigger than the formal economy and has been for years. People blithely ignore all idiotic govt. regulations. I am not saying this is an ideal situations, but this is how people respond when resources are scarce and govt. demands/regulations are simply unrealistic.
Bjorn
January 24th, 2009 at 5:05 pm

Hi Mike,

I once asked you what you would do regarding gold if you had to hold it within the United States. You weren’t too happy with the Perth Mint (Austrilian Gov’t). You obviously like Zurich, but I only know of one outfit to go with there, and I cannot work with them. It’s the group recommended by Prechter.

You said that you would hold gold coins and hope for the best.

Do you still feel that way? I am still anticipating that gold prices will come down. I’m just taking a gamble that they will. But, I’m very concerned about the US gov’t controling the the buying and selling of gold once again, thus leaving me with coins I cannot sell legally.

Do you have any further thoughts on how you would handle this if you were going to go through this depression living in the United States?

Thanks
Mike
January 24th, 2009 at 5:57 pm

GG — The scenario you describe regarding the breakdown of government and development of an underground economy is certainly possible, but in India and Latin America the government is just powerful enough to really mess things up. It’s better than full-on communism, and in some ways freer and more dynamic than western European socialism, but nothing like the old US that we all miss.
Mike
January 24th, 2009 at 6:03 pm

Hi Bjorn.

I’m sorry, I don’t remember your reason for not wanting to use goldmoney or bullionvault. And I am curious, what is your reservation regarding the outfit Prechter recommends?

Confiscation is unlikely in my mind, since the government doesn’t use gold anymore. I would guess that the most likely scenario, should they turn hostile on gold, is very high taxation of gains or transactions. If you don’t want to use a foreign vehicle, there is really not a lot you can legally do about it other than hope for the best. Even if you hold yours outside of the states, as a citizen you will likely be subject to whatever rules they may enact. It is a very tough call — if they want to strongly discourage the use of gold, they still have the power to do so.
GG
January 25th, 2009 at 3:29 am

“You never know. That’s why I own a bunch of gold.”

What I have said (a sovereign/banking system blowup) is not an outlier or “unpredictable” scenario - if you have eyes, ears and your mind open, this is THE scenario - and it’s gonna happen this year. If you’re not seeing this, you can’t blame it on “unpredictable” events - just like I KNOW Mike Shedlock is going to. Goodbye “deflation”, etc. Mish is going to lose all credibility and ruin scores who follow his advice.

Come back to this post in an year.
GG
January 25th, 2009 at 3:39 am

Mish has started comparing US’s situation with Japan for Christ’s sake! He thinks US is gonna wobble in and out of deflation for a decade to come (see his latest post: http://globaleconomicanalysis.blogspot.com/2009/01/is-big-inflation-coming.html). His cockiness and the way he is gloating and picking up and thrashing anybody who even seems have a point of view other than “deflation” makes me think that there is going to a lot of egg on his face in the near future.
GG
January 25th, 2009 at 4:18 am

Deflationists like Mish are still in denial regarding the magnitude of change we face. Most people, like Mish, are still trying to maximize gains in terms of fiat money. Currencies are going to die off. Stock markets are going to be shuttered. People are going to have to become a lot more self reliant. Just waving an IOU-NOTHING piece of paper is not going to get you the stuff you need or want.
Bjorn
January 25th, 2009 at 10:47 am

Mike,

Yes, there is Goldmoney. The Channel Islands are supposedly somewhat removed politically from the UK, unlike Bullion Vault’s location, but there is something about the UK that gives me pause. It seems a little like jumping from the frying pan into the fire.

Your thoughts on the possible use of taxation to discourage gold are very interesting. I had not considered that angle. That type of approach, if taken, would be more bearable than an outright restriction on the sale of gold, which is my big concern. I agree that outright confiscation is highly unlikely.

Regarding the outfit recommended by Prechter, it’s a little difficult to comment on the blogsite about it. Without a doubt, they have covered their bases as no one else has.

Thanks again
hcrosby
January 25th, 2009 at 11:08 am

It seems clear that the deflationary collapse is happening much faster than most predicted. Real unemployment numbers are already approaching 20%….not the phony gov’t number of 7.3%.

But I believe this mess will move directly from the deflationary collapse we are now experiencing into a hyperinflationary spiral, without any intervening “recovery”.

Economies do not transition from rosy little recoveries into hyperinflation. That’s not what happened in Wiemar Germany, and it is not what has happened in modern day Zimbabwe, either. Rather, they move rapidly from high unemployment, weak economies into hyperinflation almost overnight. In December of 1922, it took 3 marks to buy a dozen eggs (Germany was in a post Great War depression), by September of 1923 (nine months later) it took over 1 billion marks to buy those eggs.

The modern day mega state has inflationary tools available that were unknown in the 1930’s. (USA was constrained by a gold standard). Who is going to buy the two trillion worth of bonds the USA will have to issue to fund its current 2009 deficit? The Chinese? No, the FED will monitize it, along with bank bailouts, mortgage bailouts, auto bailouts, insurance bailouts and God knows what else.

Hyperinflation will be with us very soon, in my view.
Mike
January 25th, 2009 at 11:44 am

The key difference between the US and a Zimbabwe or Weimar situation is debt. When a system has this much debt outstanding (50 trillion, vs. 2.5 trillion in cash) and the bubble bursts, that debt load props up the currency. Regardless of how much confidence people have in the dollar (and it is very little right now, just as it is going up against everything, ironically), they still desperately need dollars to pay their debt.

Until the vast majority of debt is forgiven by edict or defaulted on, it will keep everyone locked into the currency. The lack of savings and earnings, as opposed to Japan, actually makes the deflation more severe, since currency is even more scarce.

Yes, the Fed has printed up a fresh 1.5 trillion and counting, but it is just sitting in banks that are still way too insolvent to start making loans again. Responsible people don’t want loans now, and banks are done making loans to the irresponsible.
Mike
January 25th, 2009 at 11:49 am

Again, the timing is uncertain on all of this, but the bailouts are actually serving to prolong the deflation — they make it milder, but longer, since it drags out the default process. We would probably be at least halfway done by now if it weren’t for the Fed, but they are keeping us locked into this perverse condition of misallocated resources.
Tom
January 25th, 2009 at 12:09 pm

Mike,
Are you not worried about betting against the GDX given these two conditions?: 1) One of the larger cost components in gold production is energy. 2) The relative purchasing power of gold tends to rise during deflation. The two combined should push earning of the GDX higher in the next two years, I would think.
Tom
Mike
January 25th, 2009 at 1:37 pm

Yes, the costs are going down for miners. This is very good in the long run.

Gold’s value is going up versus most other assets, sure, but that can happen even as its nominal value falls, reducing the gains in margin that might otherwise be seen.

Earnings are still scarce in the industry, even among the larger companies. As the stock market as a whole tanks, people will look for high and sustained dividends as the only justification for the risk of capital loss. Miners rarely pay dividends, and earnings ratios are very high.

The GDX trade is short-term, though. I just think it is overbought after doubling in a few weeks, and stands to suffer with either another stock market or gold decline.
GG
January 25th, 2009 at 2:28 pm

“hcrosby” gets it. I agree that dollar denominated debt is akin to a short position on the dollar and since now everybody is rushing to cover that HUGE short position, it is leading to a rise in dollar demand and hence propping it up. But - and these are the kinds of things that are going to make the so-called “Great” depression look like a walk in the park - henceforth the defaults and bankruptcies are going to take place with blazing speed, as will a lot of other stuff. The speed and depth of the events will surprise a lot of enlightened commentators as well. I don’t remember where I read it but, being an engineer, I liked the mathematical analogy - the change we have witnessed so far was just the first derivative, we will now be entering the SECOND derivative.
GG
January 25th, 2009 at 3:18 pm

Hey Bjorn,

Sorry to butt-in here. Your first option should be to get out of the USA (and yes, you are right - US/UK is the frying pan/fire situation).

Now I don’t have any experience buying Gold inside the US, but if you can’t relocate outside the US, I’d try to go buy the gold in person using cash so as to leave no paper trail/evidence of me buying it. Then I’d try to hide it someplace where the govt. physically won’t be able to find it. And don’t think your home is safe from illegal searches either. I have ABSOLUTELY NO DOUBT in my mind that the US govt. will steep so low as to literally steal people’s Gold - AGAIN - and using WHATEVER means necessary. Also, I wouldn’t trust ANY third party with my Gold no matter how well deserved their reputation.
Bridget
January 26th, 2009 at 10:04 am

Thanks, Mike.
Clarium
January 30th, 2009 at 6:57 am

I do not know if there will be a massive sell-off in gold because the key question is who is buying it, and how leveraged they are. I doubt the people who are buying the gold now are likely to sell it in a few years, and these people, I speculate, are generally wealthy so they could take a “paper” loss if gold falls in “value.” It is unlikely that this would faciliate panic selling (you did not argue for this though.)

I doubt those people would sell gold now due to a lack of liquidity, since they presumably have other assets with the necessary liquidity.

The gold market would be illiquid, and its price would be decided by a few number of bidders and sellers as most of the people who are holding gold or rolling over the futures (they might pay a small premium if there is a contange) because they hold it for diversification reasons to hedge against certain non-trivial outcomes where gold would have more utility. Of course, those people probably have flatter discount curves so they are willing to hold the gold.

Basically my argument against your hypothesis is that these people do not struggle to pay debt or bills so they do not have an immediate need to convert gold to cash. (Taxes might be somewhat different.)
GoldMarket Paul
June 16th, 2009 at 11:30 am

Gold has a long way to go before it reaches its peak. Deflationary fears may be over, but we are headed for a period of heavy inflation (it may take a while to reach, but I think it’s coming) and that will reignite people’s awareness of having to protect their savings.