Interview With A Gold Bear

The bear is Brian Nick with Barclay's Asset Management, and his main reason is there's no inflation on the horizon. Only gold has priced in inflation: bonds, including inflation-protected TIPS, haven't. He think the analogy of today's near-zero interest rates being like 2003-4's too-low rates is a false one; if anything, because of high unemployment and the output gap, a zero-rate policy without additional quantiative easing is restrictive. He believes that gold will break its nine-year winning streak this year, and that a reasonable price is about $700/oz given current conditions. In his words:

[Interviewer]: Is gold's long-term average of $700-800/oz a fair value for the metal?

Nick: Yes. In fact, if the Fed is a little more restrictive than normal - which we think it is - it should actually be a little below that number. But as we see interest rates start to normalize, and the economy start to improve, I think that's going to work itself out. So a return to an equilibrium price somewhere in that range is what we expect. We don't necessarily have a target date or time horizon, but we think gold will trend lower overall.

He fits the profile of an old-pro skeptic that sees a nascent bubble. His historical ratio is one familiar to gold-market watchers: the ratio between gold investment demand versus demand for other reasons. It did get seriously out of whack last year, with investment demand rocketing up well above norms; Nick sees this as a bad sign. In his own words:

The gold market has really changed, as far as the makeup in where demand is coming from. One of the reasons why I think you've seen such a sharp, dramatic run-up is that it's become a lot easier for the mom-and-pop investors to invest in gold. There are ETFs now, like GLD (GLD), that you can buy through your online trading account that hold gold directly in the fund, and you don't have to find a way to store the physical. So it's a lot easier to buy and sell, and it's a much more liquid market than it was.

As a result of that, and as a result of the recession we just came out of, investment demand has really swamped demand coming from end-users of gold, whether they're jewelry makers or industrial users. We've really seen investment demand take over the market.

That worries us, because as quickly as that demand ramped up, it could also unwind. And so you have the potential for so much gold coming on to the market, as people are selling out of their positions, but there's very little demand to soak up the supply. So we think, if the correction starts to happen, it could happen very quickly, because there's close to a decade worth of industrial demand already sitting out there in the gold market. There's no way end-users of gold can absorb all the supply out there without taking much lower prices for it.

Unlike the MSM-grounded skeptic or the outside observer who usually has little time for gold, Nick is an expert on the market. His analysis is rooted in supply-and-demand considerations normally used in the commodity markets, and his demand analysis for gold is based upon the old standard of future inflation. He fits the bill of a market professional who finds the price of an asset wildly above what it should be based upon historical norms, which is a condition that accompanies a nascent bubble.

If the gold bubble goes from nascent to full-bloom, he's the inside fellow who's going to be confounded. It's quite unorthodox to believe that rising investment demand is bullish for the metal, except in the near term. If he winds up being wrong, especially if embarrasingly so, then the nascent bubble is ready to roll.

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Speaking of unorthodox, Jeff Neilson fits the bill; he's one of those goldbugs who believes that the gold market is held back by price-suppression schemes. He argues that shrinkage in gold ETF holdings may be good for gold if the proceeds are used to buy physical bullion instead. He also claims that gold ETF holdings are double-counted in inventory reports, so a shrinking in those holdings leads to an overall reported-supply drop. If reported supply drops, then the fundamanetal picture for gold looks better provided that demand is unchanged.