Shorting Gold: 12 Reasons Making The Case For This Contrarian Investment
by Louis Basenese, Advisory Panelist
Wednesday, February 11, 2009: Issue #933
If you're a self-professed "Goldbug," feel free to read no further. Or at least spare me your hate mail. Because no matter what I say today, I know you'll cry foul... or something much more colorful.
But for those of you with an open mind - especially after my last three contrarian predictions proved dead accurate, read on.
Because it's time to start shorting gold!
You won't find many, if anyone else, making this case. But as the first reason of 12 below reveals, that's precisely why you should give it more credence.
12 Reasons To Start Shorting Gold
- It's decidedly contrarian. If a contrarian investor is someone who deliberately decides to go against the prevailing wisdom of other investors, shorting gold certainly fits the bill. Right now, everyone else is buying gold, or at least recommending it. If you have any doubt we've reached such fever pitch levels, consider No. 2.
- The infomercial factor. The best indicator of a turning point for any investment, in my experience, is infomercials. If an investment gets so popular it invades the pre-dawn hours with non-stop but-wait-there's-more offers, it's time to get out. And that's exactly what's happening now. So much so companies like Cash4Gold.com are invading primetime television. They even splurged for a Super Bowl ad spot. And they recruited washed-up celebrities Ed McMahon and M.C. Hammer to boot. In case you forgot, the Hammer filed bankruptcy in 1996. And Eddie boy almost lost his 7,000 square-foot, $6.5 million Beverly Hills pad to foreclosure. No offense, if you take investment cues from these two, you deserve to lose money.
- There is always some truth in a rumor. Recent news reports suggested Germany, the world's second-largest holder of gold, was selling some from its vaults to trim its deficit. It turned out to be a rumor. But you gotta wonder if there's some truth behind it. After all, high gold prices would be an easy way to raise cash. In other words, the scenario is completely plausible. And if Germany's considering it, even remotely, so, too, are plenty of other deficit-ridden governments. It goes without saying that a government dumping supply on the market will send prices lower, quickly.
- The gold-to-oil ratio is out of whack. Historically, an ounce of gold will buy you about 14 barrels of oil. But with oil around $40 per barrel, an ounce of gold gets you almost 23 barrels - a whopping 64% above the historical mean. If you believe in statistics, a reversion to the mean is imminent!
- So is the gold-to-silver ratio. Historically, an ounce of gold will buy you 31 ounces of silver. But now the ratio stands at 73 - an unbelievable 134% above the historical mean. Here, too, a reversion to the mean is imminent. And I'd rather place my bets on a 57% decrease in the price of gold, than silver more than doubling to make it happen.
- The HGNSI index is too high at 60.9%. For the past 25 years, Hulbert Financial Digest has tracked the average recommended gold market exposure among a subset of gold-timing newsletters. It usually fleshes out around 32.6%. But now it rests at 60.9%, a level it's only exceeded 13% of the time. The key - Hulbert found an inverse correlation exists between his proprietary index and the short-term market direction of gold. In other words, if the index is high, like now, gold is headed lower.
- Trinkets drive demand, not governments or speculators. Nearly 75% of gold demand comes from the jewelry market. And if Indian brides balk at buying above $750 per ounce as the Bombay Bullion Association reports - India's gold imports cratered 81% in December - look out below. And don't be fooled into thinking investors (governments or speculators) will pick up the slack. As HSBC reports, rising demand from investors, particularly from ETFs, only offset half of the 33% decline in jewelry market demand since 2001.
- What makes now "different?" If the global economic crisis keeps getting worse, as goldbugs like to point out, why hasn't gold tested last March's high of $1,030.80 per ounce? Or blown right by it? After all, gold is supposed to increase in value as economic conditions worsen. But it hasn't lived up to expectations, not one bit. And I don't think it ever will. Ultimately, when you factor in the massive amounts of stimulus being injected into the markets, on a global level, we're close to the worst of times... and the peak for gold.
- Analysts love it. According to Bloomberg, 16 of 24 analysts surveyed by the London Bullion Market Association believe gold will reach a minimum of $1,032 per ounce this year. As we all know, analysts' track records are deplorable. Instead of just ignoring them, why not bet against them? The odds are definitely in our favor.
- Hedge fund buying dried up. Institutional speculators (hedge funds) played a large part in gold's run-up. But 920 of them went Kaplooey last year, according to Hedge Fund Research, Inc. Not to mention, hundreds of others hemorrhaged capital as investors demanded their money back, while those left standing ratcheted down borrowing to close to nothing, according to Rasini & C., a London-based investment adviser. In the end, gold prices will eventually reflect the absence of these former heavyweights.
- Gold is schizophrenic and the wrong personality is in control. Multiple motivations exist to buy gold including the desire for a safe haven, currency, adornment, raw material, or inflation hedge. But much like Treasuries, the bulk of buyers come from the safe haven camp today. And once the economy shows any signs of perking up, we can expect these same investors to flee for more risky assets. And don't be so quick to rule out a second half recovery...
- The Fed, the President, history and the Baltic Dry Index concur - the economy's on the mend. Despite dismal data, both the Fed and President Obama point to the current recession ending by the second half of 2009. Moreover, the average recession only lasts 14.4 months. So even if this one is longer than usual, we're still near the tail end of it. A fact underscored by the recent 61.4% rally in the Baltic Dry Index from its early December low. As I wrote in November 2008, the index is the first pure indicator of an uptick in global activity. And once the economy gets back into gear, the Fed will act quickly to reign in the money supply and curb inflation.
Cleary the gold rush is on. But that's all the more reason to move in the opposite direction, against the herd. I realize this might be the most unpopular recommendation right now, but that means it could also be the most profitable.
And before you brandish me a fool for recommending shorting Treasuries and gold in the span of two months, here's the intersection. The driving force behind both assets in recent months has been safe haven buying. And it will remain the dominant variable in determining price in the months ahead. So when investors go back on the attack for more risky assets, prices for both assets will fall.
It's already happening for Treasuries. And I'm convinced gold is next.
Good (and contrarian) investing,
Today's Investment U Crib Sheet
We recommend holding 5% of your portfolio in precious metals as part of our Asset Allocation strategy. Asset allocation refers to spreading your investments among different asset classes, not just different securities or market sectors. Doing this has allowed us to survive, prosper and build our wealth during the longest bear market since The Great Depression.
We've had money invested over the last five years in foreign stocks. While the stock market has gone down, these have gone up. We've also had money invested in six other asset classes. And over that five-year time period we've beaten the S&P's return.
Now there are a couple of ways to limit your losses and lock in profits. If you're heavily invested in gold you should definitely be using trailing stops. And if you are, you might want to consider lowering your stop percentage.
The other thing you should be thinking about is the balance of your portfolio's allocation. If you've experienced gains in gold, or any other asset class, you should look at portfolio rebalancing. It's a simple approach to guarantee you're selling high and buying low. Lou explains more on how to put "Rebalancing in Action."