Gold’s steady decline from early October to a six-month low has many analysts wondering aloud if the long bull market is over. We don’t think so.
There has been a cascade of factors over the past five months driving gold down from what was arguably an exaggerated high, culminating in a series of news this past week.
- Improving U.S. economic reports along with a strong global stock market, has led to a sense that gold was no longer so necessary
- There has been an increasing focus on a future end to Federal Reserve stimulus, sparked by mid-December release of Open Market Committee minutes in which “some members” though bond buying would end in 2013.
- The euro has declined sharply this month
- Hedge funds were exiting gold at the end of the year, and several filings last week confirmed this, notably news that George Soros had cut his gold holdings in half, and other funds had sold completely.
- Fed Head Bernanke’s comments last week about the improving U.S. economy aggravated concerns that an end to the Fed’s stimulus is ahead.
Is it really so bad?
As often occurs, once sentiment changes and a market sets out on a trend, any and every piece of news is read in that light, for gold over the past few months that means negatively. We should put this in context however. The drop from October peak to last week’s low is barely 10% in a market that has risen year-over-year for 11 years now. While all of the factors listed above are valid to some extent, they are exaggerated or distorted in my view.
Although the U.S. economy has been improving, you can hardly call it robust while Japan and Europe both reported weak GDP numbers last week. For the U.S. unemployment remains high, as do debt levels. And while stocks have experienced a strong run, the fact that retail investors have started to pour money into equity funds, for the first time since mid-2008, should give a contrarian pause as to how long this rally may last.
Though “some members” of the FOMC thought bond buying would end, the same minutes made clear that the “very accommodative” monetary policy would continue, even after the economy had improved. With the new government in Japan embarked on a new easy money course, and the new Governor of the Bank of England suggesting that more stimulus is needed, easy money is global, and, whether or not policy in the U.S. becomes somewhat less easy, it is difficult to imagine policy here or overseas tightening any time soon. Monetary policy remains very supportive of gold.
Hedge funds tend to jump on trends move quickly, so it is no surprise that they boarded the stock market express late last year, while others moved to take advantage of currency movements. For a contrarian, the fact that hedge funds have sharply reduced their gold holdings is a positive sign. Perhaps at the next budget impasse in Washington, they will exit stocks and move back to gold.
Another contrarian indicator is the rapid increase in short selling of gold. According to Standard Chartered, there are 168 tons of gold sold short, well over the five-year average of 100 tons. What has been sold short, has to be bought back eventually.
Lastly, various indicators have reached new extremes, including the oscillator indicator back to extremes last seen at the beginning of 2009, suggesting a near-term reversal.
Sell now and buy back cheaper?
One can’t be sure how much lower or for how much longer gold will fall, but we are closer to the bottom than the top, for both gold and gold shares. The fundamentals remain positive for gold, while valuation indicators for gold and shares are near long-term lows. The clear breakdown of budget talks may provide the trigger for selling the stock market and moving back into gold.
As for gold stocks, the seniors continue to face head winds, including rapidly rising costs and rapacious governments. Many exploration companies are running out of cash.
Certainly, if you own companies with weak balance sheets or for which there is no likely near-term trigger, you might re-evaluate. But every stock on our list is there for a reason, be they low-risk companies or high-risk speculations. As we have found, gold stocks can do very well, but they are volatile. Selling with the intention to buy back cheaper can backfire. The worst mistake is to buy for the long term, hold during the decline, only to sell at the bottom. You need to hold throughout the cycle to be successful.