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The Bottom Line #8 – Where have all the Gold Bulls gone?

The Bottom Line #8 – Where have all the Gold Bulls gone?


O accursed hunger of gold, to what dost thou not compel human hearts!” – Virgil

Deficit spending is simply a scheme for the 'hidden' confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” – Alan Greenspan

Gold is not necessary. I have no interest in gold. We'll build a solid state, without an ounce of gold behind it. Anyone who sells above the set prices, let him be marched off to a concentration. That's the bastion of money.” – Adolf Hitler

If you give a woman a gold ring, she's going to be very happy.  If you give her one made of paper, I don't think you'll get very far.”  – Peter Schiff

If you don't trust gold, do you trust the logic of taking a beautiful pine tree, worth about $4,000 – $5,000, cutting it up, turning it into pulp and then paper, putting some ink on it and then calling it one billion dollars?” – Kenneth J. Gerbino

As 2011 comes to a close, gold bulls are spending more time on the defensive.  It amazes us just how quickly some people seem to lose conviction in their investment ideas just because the price moves against you.  Over the last month, for those who don’t follow such things, the price of gold has dropped from over $1700 at the end of November to a current price of roughly $1,535, and many newspapers and investment letters wondered aloud if gold’s “bubble” had burst.  Against this backdrop, we thought we would use the last Bottom Line of 2011 to tell our readers why we think this price drop is a tremendous buying opportunity in the precious metals space,  burst a few misconceptions about the metal, and remind people why they are in this trade (or should be!) in the first place.  We’ve also included a couple of pretty charts.

The question most people are asking us these days is why is gold dropping?  There are several culprits that we can identify, and probably many that we can’t.  The first is the recent strength in the US dollar relative to the Euro and other currencies.  All else being equal, when the dollar goes up, dollar-denominated assets will go down.  Exacerbating the situation are a number of other factors.  First, when markets sold off, the margin clerks took over, and over-levered investors sell not what they want to sell, but what they can sell.  We think this has contributed to the weakness.  Second, the well-publicized economic weakness in Europe, and the relative disinterest in the capital markets for European debt, may have forced some of the weaker central banks to sell gold into the market to raise money for planned or necessary expenditures.  Third, the very large Paulson Fund, which has the GLD gold ETF as its largest position, has been experiencing significant redemptions owing to its recent poor performance, and has likely been liquidating gold to raise funds.  It may also be that the “fast money” has moved on, at least for now, because some technical indicators were broken on the gold charts (more on this later).  Finally, the market may have been disappointed that there was no formal announcement of QE3.  None of these reasons change the investment rationale for owning gold, in our opinion.Perhaps these answers don’t provide the clarity investors seek before adding to their positions, but in our view, you can either get clarity, or you can get a good deal, but you can’t get both.

One of the concerns we hear from clients is: “gold is so volatile; should I own something this volatile in my portfolio?”  The first comment we’d make is that volatility creates opportunity, so in and of itself, volatility shouldn’t be viewed as a bad thing.  We find it interesting that no one seems to think that they should avoid the S&P simply because it’s been volatile, but when it comes to gold, they should.As Peter Schiff pointed out recently, both gold and the Dow are off roughly the same percentage from their all-time highs, but no one is calling for the Dow to plunge, simply because it’s off from its high, yet many pundits seem to be comfortable making that call about gold!When the last big gold bull market ended, gold lost 75% from its prior high before starting this bull run.  That sounds pretty bad, but bear in mind, “Blue chip” stocks like Bank of America lost roughly 90% of its value from the high, while Citigroup lost roughly 95% of its value, not to mention worse performers like Freddie Mac, Fannie Mae, Lehman Brothers or Nortel, and we can’t see gold going bankrupt….  If anything, this tells us that timing has an impact on returns, something that should be pretty obvious to investors!  The important point here is that gold is still demonstrably in a bull market, something we wouldn’t be so comfortable claiming about the Dow, and in bull markets, buying the dips is a good strategy.  Have a look at our first pretty chart, and you’ll see that this pullback is right in line with otherpullbacks we’ve lived through in this gold bull:

One thing that you can see from this chart is that every year of this bull run, without exception, has seen at least one pullback of over 7.5%.  Another interesting point is that for this current pullback to stick out, gold would have to drop more than 28% from its recent high, which would bring it down to around $1,385, well below its current price.

Earlier, we mentioned those technical indicators that had been breached.  The one that seemed to get the most press was when gold dropped below $1,600 and below its 200-day moving average, as seen in the chart below:

Source BI Money Game

This was the move that prompted gold skeptics like NourielRoubini to renew their bearish calls on gold.  To wit: “Since gold has no intrinsic value, there are significant risks of a downward correction”.  Oh sorry, that’s what Mr. Roubini said in December of 2009, when gold was trading around $1,000.  What he said this December in one of his many tweets was “Where is 2000 dear gold bugs?”  Indeed.  Of course he missed the move from $1,000 to $1,900 in the first place, so I guess we shouldn’t worry too much about his views on this….  Mr. Roubini, who we greatly respect, by the way (just not on gold), added a couple of days later that he had “no view on that Barbarous Relic.  I would rather buy Spam”, and he was far from alone.  A couple of days later the FT ran with a story entitled “The gold chart that’s converting non-believers”, and included a chart just like the one above.  When gold broke its 200-day moving average, the paradigm shifted.  Or so we were told. 

We much prefer the chart below.  What this shows quite clearly, is that the level to watch from a technical perspective is gold’s 300-day moving average, roughly $1,525, right around the lows of the day as we write, by the way, and a level at which we think gold will find support.  Even if it does violate the average, we think it will be short-lived, and as the chart shows, a great buying opportunity, like it was in 2000 and 2009.

Source The Chart Store

We can’t move on from Mr. Roubini until we address his “intrinsic value” comment.  Gold, according to Mr. Roubini, has no “intrinsic value”, so it could just as easily be worth zero as $2,000.  Here’s our question: what’s the intrinsic value of a dollar?  Or of a Euro?  What’s the intrinsic value of a US Treasury bill?  While it’s true that gold has no maturity date, what’s the maturity date of a dollar?  How many ounces of gold can the US central bank print tomorrow?  You get the point.

A look back at some trading history in gold should give you an idea of why we think it’s a good time to add.  Back in May of 2006, gold hit a new multi-year high of $710.  In around a month, it lost almost 28% of its value and dropped to $556.  If you were lucky enough to buy it at its low trade that month, you’d have made 17% on your money within two months.  Interestingly, if you had been unlucky enough to have bought it at $710, you would still have been 14% richer within 18 months.  Fast forward to 2008, and in March of that year, gold hit a new high of $995.  It then dropped off 28% again, trading down to $693 in October.  If you had been lucky enough to have bought it at the low trade this time, you’d have been up 43% by February of the following year, just shy of 4 months later!  And again, if you had been unlucky enough to have high-ticked it, 18 months later you would still have been up a respectable 20%.

Is it different this time?  We don’t think so.  Gold is off almost 20% from its high, so we’re at the high end of the range of pullbacks. If you buy gold today, we think it will take a lot less than 18 months for you to be happy you did.  We’d like to take this opportunity to remind our readers that we aren’t gold bugs; we buy assets that we think are cheap (if you want to talk about farmland for instance, give us a call).  There will come a day that we head for the exit, but for now, gold still represents the best insurance against poor central bank policy, of which we see more and more every day.  Gold is still massively under-owned by institutions relative to historic levels of ownership and relative to their holdings in other asset classes.  Gold can’t be printed 24 hours a day like dollars can.  Gold has been accepted as a currency for far longer, and in many more places, than even the most successful currencies in history.  And it’s still incredibly easy to find skeptics who call the shiny metal a “barbarous relic”.  Until that changes, we’re sticking with our strategy.  Happy New Year, and that’s the Bottom Line for 2011.  See you in 2012, when gold hits $2,000?  That’s where we think it is, Mr. Roubini, right in front of us….


Paul Azeff and Kory Bobrow are Investment Advisors and Senior Market Strategists in the Montreal office of Euro Pacific Canada and can be reached at 514 940-5093 or via email at

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