One of my favorite quotes of all time is the following from Paul Tudor Jones:
“Prices move first, then come the fundamentals.”
This is true for all markets, but it’s a particularly useful framework for looking at the precious metals markets.
For months now, gold bulls have continued to argue that the fundamentals are still strong, and that gold is on sale. This argument is rather confusing to me. Gold is simply not priced by any fundamental mechanism. Rather, an investment in gold is based on the idea that someone down the line is going to be wanting to pay a higher price for your gold, presumably for the same reasons you bought it.
But the reasons for buying gold have become awfully tired in the past couple of years. They’re based on a fearful, unrealistic viewpoint of the world that has always been an unprofitable lens through which to look.
A Flawed Framework
The idea that gold is an inflation hedge doesn’t go nearly far enough to make gold a compelling investment. Equities (SPY) have outperformed gold spot prices by an enormous margin over the past 200 years. Take a look at this table (source):
These inflation-adjusted returns reflect reality: gold has no intrinsic value, little use, and its supply increases with time.
Gold doesn’t pay dividends, it doesn’t buy itself back, and it doesn’t produce any underlying earnings. Furthermore, the amount of supply of gold is about 100 times the amount that’s physically consumed in any given year. The paper gold market is also enormous relative to supply, so those concerned with India’s demand for jewelry or whatever obscure news story is making headlines are focusing on the wrong things.
The only thing that matters with gold is if someone will be willing to pay more for it. I’m a believer that price action itself is the only cue that really drives gold prices. While retail investors and a few hedge funds may simply sit on physical gold or ETFs (GLD), commodities’ funds are responsible for the ebb and flow of market activity. Their trading activities are based on their interpretation of market activity and technicals.
Even more so than most commodities or other asset classes, points of resistance and support for gold tend to fall on nice round numbers like $1,800, $1,650, $1,550 etc. This reflects the psychological importance of different price points, and the lack of even long-term fundamental influences.
After 12 years of price increases, I felt a major psychological change was on the way for 2013, and wrote that the bull market would end this year.
I’ve written extensively about the lack of a catalyst (which has typically been accelerated expansion of the Fed’s balance sheet), changing correlations (which result in the questioning of investment theses), and market dynamics (more on this below) that have sent gold tumbling since running into resistance for the third time at $1,800.
The so-called market dynamics that I believe are accelerating gold’s decline are the forced redemptions by major funds that have had their economic and market forecasts stomped on. Enormous funds like John Paulson’s Paulson & Co. have continued to bet on the continuation of the “fear trade.”
With their portfolios undergoing heavy losses elsewhere (short equities, long safe haven currencies ex. US dollar, short distressed sovereign debt, long CDS) my theory is that they’ve begun to accelerate their exodus from gold to reposition themselves as long risk, and/or to cover redemptions.
Simple tourist technical analysis of gold’s chart has worked exceptionally well since gold failed to break out above $1,800 (see key supports taken out at $1,700, $1,650, $1,620 and the increase in selling following the breaks).
On Wednesday, despite broad weakness in equities (which has generally led to modest, temporary gold price increases in the past few weeks) gold futures were down about 1.25% to $1,555, touching off $1,550.
This comes after taking out the $1,565/$1,560 region, which was the bottom of the new $50 range I recently observed:
On the long-term GLD chart, you can see the break below $151.50 and long-term support at $130, which corresponds with a spot gold price of about $1,335:
$130 was the bottom of gold’s consolidation range before gold began its parabolic run-up to $1,900.
Being long anything gold right now – futures, ETFs, miners – is toxic. There still seems to be overwhelming sentiment that gold is on sale right now and being long offers a nice risk-reward profile.
Based on the technicals, the next strong support is more than 13% below today’s prices, and I fail to see a genuine, fresh catalyst that will drive it (and sustain it) meaningfully higher from here.
Additional disclosure: Short GLD via put options, short gold futures.