Special Alert Gold Price Outlook
Gold prices ended down sharply today (-$27.50) to close at $1670.70 on the nearest contract, which makes for a lower intermediate low and ruins the pattern of higher lows that emerged from the November low. Technically this is a worrisome development as it stretches out what should have been just a relatively normal correction to something a little bit more significant despite all the ostensibly bullish fundamentals.
I was expecting support to be stronger at the $1685 level despite my somewhat bearish short term concerns (see recent commentaries).
Now, it looks like we are going straight to $1600. For much of the past year until September’s QE3 announcement I worried about the outlier risk of a low of $1350 (based on a brightening stock and economic outlook). That low never materialized. And I abandoned that downside risk on news of the Fed’s QE announcement in September. The FOMC’s recent announcement last week only supports that decision further.
Unlike most of the rest of the world, we did not believe that the bull run in gold or stocks required any more easing by the Fed to sustain it back then, so we were surprised by the decision in the first place, and especially by its overt easiness; though at the same time it was easy to acknowledge that since the whole world anticipated some type of central bank action it was probably “baked in” the market somewhat.
Thus, the post September weakness in gold did not surprise me until now.
And although we saw and continue to see the Fed’s policy driven by irrational fears we did not abandon my worry over a short term correction in gold prices altogether. Only, instead of 1350, we see downside risk to the 1550 area now (the low end of the past 14 month range).
The downside, I hypothesized, could be driven by an outflow of gold into equities, especially in Europe, at first. Specifically, my forecast was for the euro to and the euro shares to recover in the short term, giving the global equity markets a boost at gold’s expense despite renewed weakness in the US dollar index. It seems counterintuitive for those of who know what this kind of monetary policy will eventually bring.
However, for many people, the results on the surface are real enough. They may have jobs – no matter how temporary – or they may think they will. So they end up believing in the recovery hypothesis, and the animal spirits may forsake the metal for a brief flirtation with risk.
One of the things we’re seeing now in support of that trend is a back up in Treasury yields, sort of as Goldman predicted.
So far it has been less than 30 basis points in the 10yr, and it is nominal (not real), but we feel very strongly that this trend will continue higher after one more retest of the low, say, perhaps if the basel 3 arrangement adds fresh demand to the Treasury market. In our portfolio we recommend a 5% allocation to the proshares ultrashort 20+ year treasury ETF as just a toehold for now, but would consider doubling that exposure to 10% in order to hedge some of the decline in gold prices brought about by followers of the Gibson’s paradox type argument proposed by Goldman Sachs, which I critiqued separately this month. Of course, unlike Goldman, I have been warning about this as a ‘short term’ risk related more to the effects of monetary policy on the “animal spirits”, and not as representing the end of the bull market in gold.
For this latter event to happen you can’t have a recovery that is really just another inflationary boom produced by central bank policy.
In any comparison with 1981, especially, it is important to remember that the Federal Reserve of that period was no longer increasing the rate of money growth at a historically unprecedented rate. The Fed of that day had learned that it was “contributing” to the price and wage spiral, and chose to abandon its inflationary policy. The Fed of today doesn’t even know when its current zero interest rate policy will end. And it doesn’t even believe that its actions will lead to a price and wage spiral.
Hence the outlook beyond the short term is very gold bullish. The amount of money that is being created will in our view beget a price revolution at least as painful as the 1970′s episode. We are at that sweet spot where it is likely that the policy will boost asset prices to stupid levels first so that when prices and interest rates take off the central banks will be too busy preventing interest rates from exploding to worry about an exit strategy. The news will be filled with evidence of labor unrest and a budget deficit that can’t be fixed because of the new problem of higher interest rates. So we encourage you to take advantage of the weakness to add to your gold related positions, especially equities, many of which in our view have already been pushed to valuations more reminiscent of bear market conditions.