Why the Gold Slump is Not Over
by Alexander Green, Investment U Chief Investment Strategist
Monday, January 09, 2012: Issue #1682
Not long ago, my colleague Mark Skousen asked a roomful of attendees at an investment conference how many of them owned gold. Virtually every hand in the room went up.
"And how many of you have ever sold any of your gold?"
Virtually every hand in the room came down.
For many investors, gold is their "forever investment," the one asset they never plan to sell. That could be a mistake, a big one.
I can assure you that the institutional investors who have bid gold up the last few years consider the metal a "hot date," not a long-term marriage. And that bodes ill for prices in the short to medium term.
Yes, I was bearish on gold a year ago. But I'm more bearish on it today. After all, the trend is your friend.
True, gold went up in the first half of 2011 and didn't peak until August. But take a look at a five-month chart.
It's not a pretty picture.
Of course, gold is hard to value under the best of circumstances. It has very few industrial uses. It generates no earnings, pays no dividends, accrues no interest and provides no rental income. That means the best any of us can do is guess where it's headed next.
So why am I guessing it will be lower? Let me count the ways:
1. Gold is a wonderful inflation hedge. But the metal is up more than five-fold over the last 12 years and inflation is still not a problem. Is it not conceivable that inflation could tick up and gold – having already discounted this – moves lower?
2. Gold is a great performer in an economic crisis. But we already had the crisis. It ended in 2008. Things are getting slowly better, not worse.
3. With gold prices still in the stratosphere and the value of the rupee falling, India – the world's biggest consumer of gold – is likely to experience a pronounced drop-off in demand this year. Not good.
4. Gold is now well above the marginal cost of production. New mines are opening and old mines are re-opening. It's Economics 101. Greater supply depresses prices.
5. If you believe the gargantuan debt load that Washington has run up will cause gold to rally from here, you may want to think again. Japan's debt load as a percentage of GDP is more than twice ours and the end result has been disinflation, not inflation. Why will it be different this time? Indeed, George Soros and several other major speculators are openly forecasting outright deflation. That would not be good for gold.
6. Note that while gold ended the year up in 2011, gold shares dropped 16%. Already, equity investors are taking a dim view of the sustainability of gold's advance. I think they're right.
7. Investment demand for gold has soared in recent years. Seven years ago, it made up just 16% of total demand. Today it's more than 40%. But hedge fund managers who piled into gold, unlike Mom and Pop, have no emotional commitment to the metal. These are hair-trigger traders. When the primary trend turns unequivocally south, you can bet these guys will dump gold faster than a freshman girlfriend.
I'm not suggesting that anyone bail out of gold. You should hold at least 5% of your liquid assets in gold and gold stocks, and perhaps more. But if you're one of those folks I meet who has 30%, 50% ... even 80% in the barbarous relic, you're really sitting at the roulette table at 3 AM.
No one can say unequivocally that the bet won't pay off. But there could be a steep price to pay if it doesn't. The last time gold was a bubble, investors were down more than 60% two decades later.
As Mark Twain said, "History may not repeat itself. But it rhymes."