Odd Bullishess In The Gold Ranch

Despite a home-price drop in November, as measured by the S&P/Case-Shiller Home price Index, the economic news has largely been good. Consumer confidence is up for the third straight month, and the latest results are higher than expected. The IMF has revised its 2010 global-growth estimate upwards. The stock market turned up.

Given the rationale that an economic-growth pickup is bad for gold, because it presages a Fed rate hike, the bullishness in gold is surprising. After bottoming near $1,084.50 at 9:30 AM ET, gold's marched up to about $1,100. The U.S Dollar Index hit its high of 78.632 at about this time, but its pullback did not mirror gold's rise until about 10:45 AM. According to the Kitco Gold Index, the rising dollar took a bit off the gold price. "Predominant buying" explains the rise - a real reverse from earlier this morning.

What's odd is not only the economic backdrop but also the timing. Until yesterday, it's been almost normal to expect gold to be pushed down in mid-to-late morning trading, and either recover or mark time in the afternoon. This pattern began to reverse yesterday, and nearly reached full reverse today. Had it not been for an 8-8:30 pull-down, it would be completely reversed.

Needless to say: the $1090 support level, although pierced several times these last few days, has ended up holding. $1,100, although poked at today, has not been overcome.


Update: Not as of yet. After three quick pokes at $1,100, gold has slid back a little to the $1,098 range. The U.S. Dollar Index's slide to below the 78.4 level has ended. Although it's blipped upwards from 1 to 1:30 PM, it's still established a trading range centered around the 78.4 level. As of the time of this post, spot gold's at $1,098.40.

Supply-Sider's Take On Future Inflation

That supply-sider is the "Calafia Beach Pundit," and his analysis is over at Seeking Alpha. He looks at eight inflation gauges: the real broad dollar index, the gold price, the inflation-adjusted gold price, the CRB/Reuters Spot Commodity Index, Real Fed Funds, the CPI, TIPS inflation expectations, and investment-grade credit spreads. All of the charts he uses, except for TIPS inflation expectations and credit spreads, go back to the 1970s or earlier.

The picture that results is "inflation ahead" - even though the CPI hasn't really co-operated as yet. He notes in his conclusion that the Keynesian measures, such as excess capacity and unemployment, say something different:

All of these market-based indicators of inflation fundamentals are pointing in the same direction: higher. Meanwhile, traditional indicators of inflation that the Fed focuses on, such as the degree of economic slack and the unemployment rate, are pointing to very low or even negative inflation. Who's right? No one that I know has yet come up with a foolproof method or theory for predicting inflation, but I think it is reasonable to predict that inflation will be higher than the market expects (current expectations being for inflation to average 2-2.5% over the next 5-10 years).

One impression from the gold and commodity graphs is the sea-change that occurred in the '00s. In the '90s, gold was dropping and the CRB was in a long-term range, like equities are now. In the '00s, the direction for both decisively turned to the up side.

Keeping The Faith

If there's any mainstreaming of gold, as shown by both ads and media reports, it's been on the sell side. The "Cash for Gold" companies have been advertising heavily, and stories about them are becoming semi-regular in the mainstream media. There have even been reports about complaints that those companies are underpaying and even cheating their sellers.

To put it briefly, gold selling has become mainstreamed. Gold buying hasn't.

As I've written before, and almost certainly will write again, we're at a tipping point right now. Gold isn't in an all-out bubble, but it could be if the metal's bull market gets rolling again.

As the previous entry explains, a gut-level fundamental analysis shows that gold is really overvalued right now. However, a contrarian would demur. Smart money is going into gold, some in a big way, while the so-called "dumb money" (the general public) has gone for selling gold in a big way. Even if the dog doesn't bark - if gold doesn't fall despite the new supply flooding the market - we're still on the bubble side of the tipping point.


There's still gold fever out there, although it's confined to goldbug territory. This Mineweb article, discussing the outcome of a reader straw poll, gleans this scenario for gold:

Mineweb's 2010 gold price competition has now closed and, as usual readers are overall bullish about gold's prospects in the year ahead. However the consensus also sees a fall to well below current levels occurring before the price surges again to record highs. It will be interesting to see if this scenario plays out over the year.

The average ‘low' price for gold seen by readers this year is a slightly depressing $996, suggesting that the $1,000 level may be breached on the downside - but perhaps only briefly. Reading between the lines with one's own interpretation of reader expectations it looks like this low point is expected sooner rather than later in the year, and with the current surge in the dollar price levels may well be vulnerable in the short term....

By the end of this year the straw-poll consensus number for year-end is well over $1,400. Given where gold is now, and how it's acted so far this year, that number's somewhere between "very optimistic" and "LSD-influenced."


What if that consensus ends up being right, though? What happens if gold does put in another >25% gain for 2010?

I have a modest prediction. The cash-for-gold companies are already courting investigations. If gold skyrockets, it'll be much easier to cast them as "cheaters" and "crooks." One side consequence will be new laws, and even indictments on the basis of old laws rigorously (or creatively) applied.

Gold Makes One Of Four Assets Classes In Fortune Bubble List

Fortune magazine has webbed a list of four asset classes which the author of it considers to be in bubbles. The entire list makes for a real grab bag. Two on it are financial assets: U.S. stocks and U.S. Treasury bonds. The other two are commodities: gold and oil. Some may wonder if the list is self-contradictory, but the liquidity sloshing around explains how T-bonds and gold could both be considered in bubble territory right now; excess liquidity is fungible. Suffice it to say that both being in bubbles implies that bulls in each market expect different inflation outcomes.

The author, Shawn Tully, uses historical norms for each: in the case of gold and oil, he points to high prices calling forth a lot of additional supply. Here's what he has to say about gold:

Investors are rushing to gold, because they rightly fear far higher inflation in the next couple of years and want to hedge against both rising prices and a declining dollar with a commodity that, they claim, has a fixed supply.

Since early 2009, the price has jumped to $1,100 an ounce from $875, triple its average price between 1990 and 2004. Yet the supply of gold is far more fluid than the gold bugs admit, partly because mining companies are investing heavily to increase production.

The real threat: Prices are so high all over the world that people who once treasured their gold jewelry are now rushing to sell it. Swiss refiners are offering irresistible prices for bracelets and brooches, "cash-for-gold" stores are in Chicago malls, and suburbanites are hosting Tupperware-style parties where neighbors show up to hock their gold teeth.

When this happened in the early 1980s with silver, prices plummeted from $50 to $15 in less than a year. Look for gold to end up below $500 an ounce within two years.

There it is - a real mirror of any excited goldbug who's calling for $2,000-$2,500/oz within two years.


As I pointed out in the Enter Stage Right article that's "Entry Zero" of this blog, bubbles get rolling when historical measures imply that an asset is overvalued but subsequent price action mimics undervaluation. The explanatory gap is filled by a New Era story that explains the mysterious rise in terms of a fundamental value-shift to the asset's benefit. As the bubble progresses, the New Era story spreads and grows in the telling, to the point where it becomes an all-out New Era delusion.

Thanks to the popping of the August-November parabolic rise, gold's still on the cusp of an all-out bubble. The price movement of the metal doesn't defy sanity as of yet, although it briefly seemed to as of November last year. Remember the report about third-quarter world demand for gold falling 34%, which the gold market ignored back then?

Tully's argument is fundamentalist in nature, and is more gut-level than the deflationists' warnings. It applies even if inflation stays at today's mild but positive levels. Furthermore, it makes economic sense: when new supply is called forth by high prices, prices fall. That's the way markets work.

Given the supply increase he points to, his argument will be confounded even if gold stays where it is. The supply ramp-up will have been met by a corresponding ramp-up in demand, most likely investment demand. If gold stays flat this year, as I suspect it will, then we'll be watching an incubating bubble. The off-to-the-races moment will be amplified when the general public shifts from being net suppliers to net demanders, when the "Cash for Gold" companies' revenues slump while bullion sellers' soar.

Should the gold bull market turn into a bear market, the likes of Mr. Tully will say that the gold bubble has popped. Myself, I would say that an incipient bubble never got off the ground. Gold as an investment has not been mainstreamed enough for it to have engendered all-out bubble fever; nor has there been the general euphoric bliss that characterizes a full-scale bubble. In fact, the mainstreaming process hasn't proceeded all that far, and it can be argued that the process is in its early stages.

It's still cusp time...

Looking At A New Ratio Chart: Gold In Terms Of The U.S. Dollar Index

The Kitco Gold Index has performed a useful service in factoring out U.S. dollar changes from other influences on the gold price. Since only one influence is factored out, what's left is a catchall category called either "predominant buying" or "predominant selling."

A similar proxy comes from dividing the gold price by the U.S. Dollar Index. That ratio shows what one ounce of gold would cost if it were possible to buy it in U.S. dollar index units in a transaction-cost-free and perfectly arbitraged market. The daily chart, which like the others below are courtesy of Stockcharts.com, shows a almost perfect similarity to spot gold itself:





However, the longer-term chart of both shows at least two noticeable differences:





Note that the gold price was higher in February of '09 than it was in July of '08. The ratio of gold to the Index, though, was lower. This non-correspondence shows that gold went up more than would be expected given the greenback's rise in that period. On the other hand, the gold-USD Index ratio rose significantly from February to June of last year, while the gold price fell slightly in that timeframe. That difference shows that the U.S. dollar's fall in that period outpaced gold's rise.


For the last six months, as shown by the first pair of charts, the gold price in regular U.S. dollars has been moving in virtual lockstep with the price in terms of U.S. Dollar Index units. So, it's no wonder why it's now held as given that the greenback's driving gold.

The difference in the longer-term chart clearly shows gold demand as a safe-haven asset. That demand shows most clearly in the waning days of the Bush Administration. Since the February stock-market rout, that demand has at least partially dissipated. The rout marked the high point of crisis demand: as of the mid-to-late March peak, gold was down with respect to February's peak; but, the gold-to-USD-index ratio peaked at about the same level.

Sorry to say it, but there's been no obvious evidence of any safe-haven demand subsequently. It evidently takes an all-out credit crisis plus emergency inflationary measures being hurriedly slapped together - both factors have to be present - before safe-haven demand kicks in mightily.

PRC Tightening Worries Hit Gold Again

It wasn't just the gold price that was hit by looming bank-lending restrictions, either: both the Hang Seng and Shanghai indices were down about 2% last night. As for gold, a run-up that started last evening, and took the price up to about $1,102, was aborted just after 8 PM ET. The price fell back to about $1,096 by about midnight. The slump resumed at that time, and continued until $1090 was reached before 5 AM ET. Then, the metal drifted in a tight trading range, broken briefly on the downside, which lasted until 7 AM ET when the price dropped to its daily low of $1,087.80. The $1090 support level held then: another test of it, right after 8 AM ET, saw the metal bounce down to about $1,088.50. A slight recovery to the $1090 level didn't last, though; the metal was pushed down to $1,085.40 as of 8:30 AM.

As in the recent past, PRC woes benefitted the greenback. After hitting a weekly low of 78.083 yesterday evening, the U.S. Dollar Index rallied strongly last night. The rally continued early this morning, though less steeply, until a pull-back hit which lasted from 3 to 4:30 AM ET. The rally then resumed, pushing the Index to 78.553 as of about 7:20 AM. The rising dollar did its part to pull gold down, but the Kitco Gold Index attributed the drop as of 8:30 mostly to "predominant selling." At the same time, the Index recovered to above 78.5.

A Reuters report attributes the fall to the PRC's bank-lending restriction push: "China's central bank told banks that need to raise reserve ratios to implement the change on Tuesday, banking sources said." Since this isn't new news, the market's reaction last night and today suggests that the ratio-increase announcement wasn't fully assimilated by the markets at the time. Also in the report is a note about the lack of safe-haven demand for gold right now:

Gold might typically be expected to benefit at times of rising risk aversion as investors buy the metal as a haven, as happened a year ago while the financial crisis raged.

However, if risk aversion is rising but still manageable, the benefits to the dollar -- strength in which weighs on gold -- generally puts gold prices under pressure.

"(Gold's) risk-averse qualities were hardly noticeable during the latest sell-off in equities, with bullion trading against the dollar as anything else in your average commodity basket," said VTB Capital analyst Andrey Kryuchenkov in a note

Neither he nor they say it outright, but "still manageable" dovetails with "consistent with lower inflation/greenback upvaulation in the foreseeable future." I know there are goldbugs who insist that gold does well in deflation, but the only records we have of real and sustained deflation are from the days of the gold standard. It's just as easy to argue that a gold rise was discounting a future devaluation back in those days. The only fiat-money data we have are from disinflationary periods, during which gold has typically suffered.

A Bloomberg report carries this quote from Dennis Gartman:

“Given the pressure put upon the commodity markets generally by a strong dollar, it shall be hard for gold to hold itself erect,” Dennis Gartman, a Suffolk, Virginia-based economist and hedge-fund manager, told clients in his Gartman Letter today. Some investors may sell the metal because “capital can be raised to meet demands in other markets from gold,” he said.

That factor - a liquidation trade to free up funds to cover other losses - is one that hasn't been mentioned of late. Given that gold rallied strongly last year, and was pushed down hard in the '08 crisis but not in March of '09, it could be argued that it was pushed down much more strongly by a much larger liquidation trade back in the summer and fall of '08.

The spot gold to GLD ratio - what I've been calling "the gold at a discount indicator," even though I did not find it useful for personal-finance purposes - closed at 10.22 yesterday. In other words, at market's close, the price of an ounce of gold itself was 10.22 times the price of one share of GLD. That close put physical gold at a slightly higher premium to a GLD share than on Friday. This ratio, to remind, is presented as an item of reader interest. Yesterday, there was no veering towards an extreme one way or the other.

As of 9:04 AM ET, the greenback rally has resumed, pushing the Index to a daily high of. 78.575. Gold's decline has not. The 8:30 AM drop was only slightly recovered from, and the price turned back down to the $1,085 level fifteen minutes later. As of the time of this post, however, spot gold is slightly above that level at $1,086.40.

Morning Gold Pouncers Largely Absent Today

Gold was carried down about $10 earlier this morning, but more than half of that movement took place before the usual pummel time of 8 AM ET. After 8, the price moved down only another $5/oz.

After moving in a somewhat downish range for an hour, gold turned up at 10 AM ET as the U.S. Dollar Index turned down. The greenback then established a trading range, and gold almost got back up to $1,100, but that resistance level wasn't breached. As of the time of this post, the range is still holding as the U.S. dollar is climbing back up. The Kitco Gold Index has gold up $3.20 as of 11:17 AM once the influence of the greenback is factored out.

For the first time in some time, it's been a quiet market price-wise. Gold hasn't really been going upward, but the widespread fears of a solid move downward have not been realized. I'd be surprised if gold gets below $1,090 today.


Update: As it turns out, gold didn't do much of anything in the afternoon. The same trading range, an tightening one, held since it was established at around 8 AM ET today. The $1,090 support level held, and so did the $1,100 resistance.

The U.S. Dollar Index remained in a range too today, bordered by 78.18 and 78.23, except for a brief dip that carried it down to 78.144 at about 3:30 PM. The same range was re-established after 4 PM and held until 5:30.

All in all, an unexciting day. Regular trading ended with nary a blip in the last hour: as of the close, spot gold was at $1,097.10 for a gain of $5.60. The Kitco Gold Index attributed $0.95 of this gain to a slight fall in the greenback and $4.65 to "predominant buying."

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For many, these following data will make for a "where was I?" moment. Nine years ago today, on January 25th, 2001, gold was at $264.90 for its London PM fix. Today's PM fix was $1,095.25. In the last nine years, gold was up by 313.5%.

If that wasn't enough to trip on the Regret-O-meter, this stat might: On January 25th, 2001, the Amex Gold Bugs Index (HUI) closed at 47.59. Today, it closed at 398.04. Nine-year gain: 736.4%.

Note that the Gold Bugs Index is not a stock, it's a basket of fifteen stocks whose members change over time. In order to capture close to that gain, the component stocks would have had to have been held in a tax-sheltered account with minimal transaction costs.

What I found interesting is the fact that the HUI does show leverage over the last nine years, even though said leverage has been notoriously absent more recently.