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Is the gold price giving us a repeat performance
of October's fake-out in the oil market? My suspicion is
that gold is acting a lot like crude did last month...running
up to fresh highs - and making headlines all the way...
But this isn't the main event. Not yet.
The day of reckoning for America, her deficits
and her dollar is surely on its way. Investors who haven't
yet bought gold as protection could be forgiven for thinking
they've missed their chance. But we may see gold make the
inevitable run up to $450 - as early as next week - and
then experience a serious correction and consolidation.
For that, investors still not holding gold
should read "last chance to buy before the bull is
untethered..."
First, note that as gold has screamed up since
the summer, gold mining stocks have failed to confirm the
move. Just as happened with the Oil Sector in October, the
underlying commodity has gotten way ahead of its producers.
For instance, gold put on $5 - one full percent - between
its Tuesday close in London and its Wednesday close in New
York this week. Yet the two biggest gold producers in the
world did not follow. AngloGold eked out a 0.56% gain on
the day; Newmont mining, the world's largest gold producer,
managed a 0.71% gain.
Is this quibbling? Well...no. Newmont climbed
as high as $49.96 in intraday trading Wednesday. But when
you take a closer look at the chart, you see that it even
though it closed up for the day, the second half of the
session was all downhill...until it reached $49.55. In short,
Newmont made a bid for $50 and couldn't make it. The largest
gold stock in the world is failing to confirm gold's bullish
move. Why?
The answer is "earnings' gravity".
If you want to buy Newmont at p/e of 50, be my guest...and
many investors will. But until the bullion price moves much
higher - and starts making its way onto the income statements
of the gold producers - the dearth of gold shares means
you have too many investors chasing too few gold stocks,
and paying too much for them. The total market capitalisation
of the gold and silver mining sector in the US is less than
$136 billion. By comparison, Microsoft's market cap is $296
billion. The equity upside of gold is limited until the
bullion upside gets much, much higher.
Of course, there is the chance that the next
"psychological level" for gold is $500 - that
being simply such a glorious number that traders can't resist
it. Kevin Kerr at Outstanding Investments believes the technicals
support gold all the way up to $475 in short order. This
move would be aided and abetted by a huge increase in speculative
longs in the futures market AND a surge in liquidity inspired
by the launch of GLD, the New York listing for the World
Gold Council's bullion backed gold fund. It's due next month,
if not in the New Year.
Several hundred million dollars could flood
into GLD as soon as it's launched. The stock will enable
US institutions to take a position in 'paper gold'. Wall
Street's appetite for such financial chimeras is growing
at what seems an exponential rate. Last week, cash inflows
into Exchange-Traded Funds exceeded US equity mutual fund
inflows for the first time that I can recall - and this
during a week when over $1.3 billion came in from the cold
of the money market to the stock market sauna!
Moreover, such a flood of funds into GLD would
be a vindication of the idea of 'paper gold', at least in
the short term. The idea behind GLD - and its London-list
equivalent GBS, which has successfully matched the price
of gold since its launch in January 2004 - is that they
introduce liquidity to the gold market and create institutional
demand for the metal. Up until now, US pension funds and
institutions - which is just a fancy way of saying mutual
funds, banks, insurance companies, and brokerages - had
no easy way to buy gold through the stock market. They had
to do it through futures contract, or buy bullion. And legally,
US pension funds weren't allowed to own commodities outright.
Few institutions want to buy bullion anyway,
because it never pays a dividend. It's essentially a savings
account with zero interest, although if the dollar is getting
worth less and less...then things priced in dollars go up...and
pure inflation becomes one way to explain the rising gold
price.
It's like a can of Coke that used to cost
25 cents now costing 75c or $1.00. Has the Coke gone up
in value? Or has the purchasing power of your money gone
down? Owning bullion when the currency inflates is one way
to profit - in terms of paper dollars, at least.
The question today is whether there is pent
up institutional demand for 'paper gold' that is bullish
for bullion. A lot of institutions could allocate a small
percentage of their cash to gold, perhaps as much as 5%.
And with gold rising in dollar terms - and also in terms
of British pounds now as well - there would be no 'yield
penalty' to pay. The gain in bullion prices would match,
or exceed, the yield on UK gilts or US Treasuries - plus
you'd have the safety of owning nature's own currency!
With paper gold like GBS and GLD accepted
and flourishing, "earnings' gravity" on gold stocks
may no longer be a check on making money in the yellow metal.
With GBS and GLD, so the theory goes, you get more liquidity
in the equity side of the gold market. And whichever way
the gold price goes in the near-term, the launch of the
new Amex Gold Miner's Index (GDM) should also be great news
for options investors if and when those vehicles become
"optionable" - especially as it's composed of
more volatile junior exploration stocks.
I made the enhanced liquidity argument myself
- about a year and a half ago, when gold was much less popular.
Today is different. Gold is "hot". But is it "hot"
in the way that, say, Britney Spears in a skin-tight red
rubber suit is "hot"? Or is gold warming up because
it's at the centre of a major shift in investor sentiment
about asset allocation and the need for diversification?
With gold making 16-year highs, the dollar
making fresh lows in euro and yen terms, I'm more inclined
to take recent developments as a sign of a near-term top
in the gold price. In contrarian terms, whenever the crowd
is all on the same side of the trade, the trade is nearly
over.
In this scenario, GLD launches...goes a-googling
its way up briefly...and then plummets to earth at the rate
of 32 feet per second per second when the lustre of the
first buy tarnishes.
That's when we should buy it. And that's when
you should go hunting for gold stocks again - buying them
at a much lower price. Or, you can do what I'm telling my
options readers: sit tight with your long gold positions,
and buy put options on them for a near-term correction in
the gold price.
In the long-term - but before we're all dead
- I'm still mega-bullish on gold. Market's rarely move in
straight lines, however. Just ask anyone who bought crude
oil futures over $55 a barrel in October.
And with so much sentiment so universally
bullish on gold, even the staunchest bug should take note.
Regards,
Dan Denning
for the Daily Reckoning
***
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