In November, gold investors were encouraged by the Federal Reserve's openness about its intention to keep the printing presses running at full capacity. The Federal Reserve Bank of Dallas President Richard Fisher went so far as to say that their current interest rate stance may be appropriate until 2011.
"Looking into 2010 and perhaps to 2011, the most likely outcome is for growth to be suboptimal, unemployment to remain a vexing problem and inflation to remain subdued," Fisher said in a speech today in Austin, Texas. "Our current policy is appropriate." Responding to audience questions, he said the dollar is undergoing a "rather orderly depreciation."
Fed officials after a meeting last week reiterated a pledge to keep the benchmark interest rate near zero for an "extended period." The unemployment rate exceeded 10 percent in October for the first time since 1983, and U.S. banks kept tightening lending standards for companies and consumers last quarter."
Scott Lanman and Steve Matthews, "Fed's Fisher Says Growth May Be Suboptimal Into 2011 (Update 1)," Bloomberg, 10 November 2009
Additionally, European Central Bank President Jean-Claude Trichet has been signaling a withdrawal of stimulus measures faster than anticipated—helping to strengthen the Euro.
All of these measures have helped propel Gold up nearly 23% since it broke above $1,000 per oz. in early September. Gold was hitting a new high almost on a daily basis in November. Even the junior mining gold stocks awoke from their year-long slumber to jump 40-50% in November. The Market Vectors Gold Mining Index (GDX) was up 37.5% at its high since the September breakout in metals—in two months! It's time for a break.
Two measures have sparked a correction in Gold last week. The first was a comment made on December 2nd by a key figure at the People's Bank of China:
"We must keep in mind the long-term effects when considering what to use as our reserves," Hu Xiaolian, a vice-governor at the People's Bank of China, told reporters in Taipei, when asked if China had plans to increase its gold holding in its foreign exchange reserves.
"We must watch out for bubbles forming on certain assets, and be careful in those areas."
Reuters, "China warns of possible gold bubble," The Globe and Mail, 2 December 2009
The second measure that economists believe helped spark the correction in gold was the "strong" (i.e. "less bad") unemployment data on Friday that strengthened the dollar. Personally, I would argue that it wasn't the unemployment data (i.e. fictitious birth/death model job creation) that helped rally the dollar; it was weak hands letting go of gold and the unwinding of the dollar carry trade.
In the early morning on Friday, stocks were up and gold was down. As gold and the gold miners continued to sell off throughout the morning, the dollar doubled its efforts to rally higher. As the dollar began to rally, the stock market's rally was squashed. After all the push-and-pull, at the end of the day, the dollar was up more than 1.7% to break above its 50-day average—something it has failed to do in eight months. The dollar rally that deflationists had called for in August may finally be upon us.
On a short term basis, precious metals stocks are oversold with only 30% of the miners in the GDX above the 20-day moving average. A short bounce could develop here if we do not have a waterfall-like crash in precious metal miners. If you’re buying the dips, it would be a good idea to dollar-cost average because the gold market is one of the hardest in the business to time.
On a more intermediate basis, 70% of the miners are above their 50-day moving average. This is a reading that seems to be rolling over from an overbought reading last week and may have some room to go. Good intermediate term buying opportunities are typically found when the percentage of stocks (in the GDX) above the 50-day moving average is less than 20%.
(The above charts are updated twice a week on FSO’s Precious Metals Homepage, here.)
The chart below shows the intra-day reversal on Wednesday (red arrow) as the GDX approached the 2008 all-time high near . The chart also shows the technical breakdown in the chart since that day. Selling begets selling in a momentum-driven market as the mantra is religiously chanted: sell first and ask questions later.
There’s a pattern to look out for here in the miners: a reverse triangle. Triangles are typically continuation formations and are recognized by Elliott Wave technicians as such. The pattern to watch out for is shown below in the chart with a zigzag, “e” wave down to support near .
This is a momentum market. There aren't any buy-and-hold investors anymore. Take a look at a chart that James Montier of Societe Generale found that I think pertains to current events:
James Montier, "Mind Matters: Six impossible things before breakfast, or how EMH has
damaged our industry," World: Global Strategy, Societe Generale, Cross Asset Research, 18 June 2009
The chart above shows that the current average holding period for a stock is just six months. Over the past 100 years, major manias in stocks have occurred when the average holding period dropped to one year. James Montier also wrote about what Keynes thought of investors who make choices in these types of markets:
"…professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the price being awarded to the competitor whose choice most nearly corresponds to the average preference of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one's judgment, are really prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be."
Quoted in Montier, pp 10 & 11
In a market where investors are anticipating which stock the next competitor will fancy, that group-think is easily shifted based on news. The Chinese have told investors that gold is in a bubble and that they wouldn't be a buyer here. Technically, the Chinese are making the right call. I wouldn't buy gold after a relentless rise of 23%. When everybody's bullish, there's nobody left to buy. When the wind shifts like it did last week, everybody jumps for the exit and crowds it.
Before the Chinese talked about gold being in a bubble on December 2nd, they were talking about needing to buy more. Things that make you go hmm…
"In fact, it is interesting that the Chinese central bank has come out with such a bold statement on gold. On Monday, a top Chinese official (Ji Xiaonan of the Assets Supervision and Administration Commission) announced that the country is eager to increase its gold reserves to 6000 tons in the next 3-5 years and 10000 tons in the next 8-10 years. Big, golden ambition, indeed. But considering the fact that China has now 1054 tons of gold, taking the yellow metal reserves to 10000 tons in the next 10 years is going to be a challenging task.
China, the fifth largest holder of gold in the world with 1054 tons, has been aggressively trying to mop up gold reserves to its foreign exchange reserves."
David Lew, "Chinese Central Bank says gold prices on a bubble," CommodityOnline, 2 December 2009
Think about it. India purchased 200 tons of IMF gold and paid ,045/oz. for it. Since then the price has skyrocketed to ,227/oz. The Chinese know that speculation has pushed prices up due to the Indian purchase and they will wait for a correction before they buy—not to mention maybe manipulate the market in their favor with a bubble announcement. Now the Chinese are getting the ample supply they need to buy 6000 tons of gold as weak hands trade out.
Is gold in a bubble? In my opinion: no. Is gold in a mania? In my opinion: yes. Let me explain the difference.
A bubble is essentially when an asset's price has been "inflated" beyond normal valuations. If gold is in a bubble, why has it underperformed most commodity prices? Since the beginning of the year, gold is down 18% versus silver, down 36% versus oil, down 40% versus copper, and down 15% versus platinum. Gold's growth is mostly attributed to the growth in industrial commodities predicated on the global growth recovery story, in addition to the decline in the dollar. If gold’s growth was mostly due to its monetary attributes (i.e. gold is money!!!), then it would have outperformed the industrial commodities—not the other way around. To say that gold is in a bubble is to say that all of its brother commodities (who have outperformed it) are also in a bubble; I just don't see the end to this global market recovery from an economic standpoint until governments turn off stimulus programs. At the point that governments eventually do turn off the financially accommodative programs, they’ve made it clear they will only do so when the cyclical economy has recovered.
Manias happen in three phases. The first stage starts with the trailblazers who correctly identify a new trend developing, but are often times too early. The second stage occurs when Wall Street traders, professional investment advisors, and newsletter writers jump on the trend when it clearly starts to outperform its peers. The final stage occurs when a trend makes the magazine covers and the trend becomes a household topic for parties and family get-togethers.
Is gold in a mania? Certifiably so. Clients are telling me they see booths set up to buy "junk" gold in their malls. There are signs posted near my gas station advertising to buy junk gold. Tupperware and candle parties have become gold parties when a night out with the girls means coming back home with 0 in your pocket. Just last night, I was talking to a 20-year-old blue-collar worker telling me about how much money he's making in gold stocks. The question gold investors should be asking themselves is how far are we in the 3rd phase of this mania?
I remember what it was like investing in gold and silver in 2002–2004. Nobody knew about the decline in the dollar and the rise in commodities because they were still talking technology stocks. Secular investment managers steered clear of the "risky" commodity asset grouping. I remember watching CNBC interviews in 2005 when the traders on Wall Street started to actively dabble in gold miners, then oil stocks, and then back to technology stocks. Today we have junk gold booths in malls, but is gold a household subject yet? You tell me.
How long can manias last? Luckily we've had two manias to observe over the last 15 years: the internet and housing manias. The internet and technology stock craze really got off its feet with America Online and Netscape in 1996, but it started with technology stocks in 1992; that ended in March 2000. The housing mania took off early this decade and peaked in 2006. The last gold mania was in the 1970s and lasted 10 years.
What ended the internet stock mania? Valuations. What collapsed the housing stock mania? Valuations. What will be the end of the precious metals stock mania? You guessed it, valuations. BMO Capital Markets just released their Gold Pages review of operating and valuation metrics for North American and global gold companies. Their average estimated P/E multiple for the senior producers is 36.2 and 25.4 for 2009E and 2010E respectively. Their average P/E multiple for the intermediate producers is 38.6 and 29.3 for 2009E and 2010E respectively. The P/E on Cisco on April 14th, 2000 was 149 times earnings. Now that's a bubble. Bubbles happen at the end of manias when greed thrives.
Summary
China has jawboned the loose hands out of gold last week. Unfortunately in these days, there are a lot of loose hands—momentum hedge funds and day traders—investing in the stock market. The dollar rally that deflationists had warned about in August may finally be here. I don't agree with the Chinese, who want to buy 10,000 tons of the metal that gold is in a bubble because we’d see gold miner valuations at much higher levels. I don't see signs of a bubble, though I do see signs of a mania. Manias can last a long time until valuations eventually skyrocket. Until I see stimulus unwind and foreign governments stop buying bullion, gold will have support.
