Gold’s Stretched-Out Rope

Thanks for all your comments on my Monday-afternoon gold analysis! You packed our inbox with interesting and insightful feedback. I appreciate having intelligent readers like you. You make my job easier — and you keep me on my toes, too.

Like me, most of our readers are long-term bullish on gold, and many if not most are somewhat short-term bullish on the shiny metal as well.

Some of you asked me to explain the “bottoming process” I see in the gold market. Others wanted information about specific gold investments. Many people are looking for practical advice on adding gold to their savings plan.

Today I’ll try to answer your questions and fill in some details. I’ll also give you a peek inside my own family investment strategy. Many publishers try to sell you this kind of information as a special report or bundled with a subscription, but we here believe it’s critical for folks to understand what we do with our money in order to understand where we are coming from.

Please read closely — we have a lot to cover and all of it is important!


Investment lingo is often colorful, but not always clear. Yesterday I wrote that gold had “touched bottom.”

Think about this phrase for a minute. What image comes to mind? Maybe you see a farmer digging through topsoil, or a Pacific Islander diving for clams. You could also imagine a bungee jumper stretching out to brush the ground before the rope snaps him back up.

Is the clam diver at the very deepest point of his lagoon? Could the farmer’s bedrock be a few feet deeper in his other pasture? Yes, of course. Figures of speech are not always literally true. We use them to evoke pictures in our minds. They help us process new information and store it in our memory.

So, am I 100% certain the gold price will not go one penny lower from here? No. I think finding bottom is a process in any market. There are no signposts to tell us when the process begins and ends. They are usually obvious only in hindsight.

In my opinion, gold is in a bottoming process. We may see gold prices drop lower as the process unfolds. We may even see an unexpected market condition that causes major players like banks and even countries to liquidate gold at some point that no one could have seen, similar to what happened to gold after the U.S. market panic in September 2008. If either happens, I think it will be temporary and short-lived. I will view them as a buying opportunity.

This is what I mean by “touching bottom.” Gold’s rope has stretched about as far as it can. We may not be at the absolute bottom, but we are darn close.


The gold “price” is a fuzzy concept even when you aren’t near a bottom. Gold has many prices. The twice-daily London “gold fix” is a semi-official benchmark, but you can also look elsewhere.

Several futures exchanges offer gold contracts. Because they represent metal for future delivery, futures prices reflect other factors like storage costs and interest rates.

Then you have the many gold ETFs and similar instruments. You can quote all these in many different currencies, too.

These prices are for what you might call “financial” gold. They involve large amounts traded wholesale, between dealers. The gold itself usually stays in a vault.

The “physical” gold at your local dealer is different. If you want to walk out with gold coins in hand, you’ll usually pay a premium to the wholesale price, however you define it.

Physical gold is currently in short supply all over the world. And at each dip in the gold market, supplies shrink. The U.S. Mint is selling American Eagle coins as fast as it can make them. Earlier this month India’s government imposed a higher import tariff to try to curb jewelry-related gold demand. Wealthy Indians simply turned to the Middle East. Gold sales in Dubai are reportedly skyrocketing.

Why do so many people want gold in hand? They all have their own reasons, but the impact hits everyone. The premium varies for different coins, but it’s not unusual for a 1-ounce coin to cost $40 or more than the “gold price” you see quoted in the media.

Keep in mind, also, that this premium can rise and fall completely independent of the “financialgold price. If enough people want gold coins, and are willing to pay for them, then eventually dealers will melt big gold bars into coins.

This doesn’t happen overnight, though, and meanwhile the coin premiums can get higher as dealer inventories shrink — possibly even to zero. They can’t sell you coins when they don’t have any.

We could also see the financial gold price bottom out well before (or after) the physical gold price. These really are two different markets. Of course, they’re closely related, but they don’t always move in lockstep.


Finally, let me tell you how gold fits into my own financial plan. Your circumstances may be different, of course. I’m in the middle of my career with a young child and a wife. Someone who is retired and living off savings and Social Security has different needs. I’m just an example.

My wife and I have agreed on a family budget. When I get a paycheck, we first pay all our normal bills: mortgage, medical, groceries, etc. Whatever amount is left goes into our savings plan.

I categorize our savings into “mental buckets.” I was fortunate enough to learn this concept early in life and it was reinforced years ago after reading a piece on savings buckets from the author of “Automatic Wealth,” Mark Ford. It simply means placing your savings in separate buckets for distinct purposes. In my family’s case, we have three buckets.

Our short-term bucket is our “rainy day” fund. We use this money for unexpected bills or minor emergencies. Since we don’t know in advance when we will need it, this money needs to be quickly accessible. We keep it in cash or near-cash investment accounts.

Our long-term bucket is for expenses we expect in the distant future: our son’s college education, retirement and hopefully enough to help some worthy charities. In this bucket, we don’t need immediate liquidity. We’ve taken advantage of this by investing in real estate and related funds with excellent potential for long-term growth.

Our mid-term bucket is between the other two. We use it to take advantage of current investment opportunities. We want to stay flexible in this bucket, so we don’t buy assets like real estate, which can take months to liquidate.

Until the last few months, this bucket held mostly stocks, ETFs and bonds. Now we are filling it with gold. I also invest in gold-related assets like mining stocks.

Since I think we are near the bottom, our plan for the year is to buy gold at regular intervals. The way I view the market, I won’t even be upset if the bottoming process takes another six to 12 months of sideways trading, but I think it will happen much sooner. I will use the time to add to my holdings, confident that I’ll sell it at much higher prices within a few years.

Could I wait to buy gold until I’m 100% confident the exact bottom is here and once the market quickly moved up 10% to confirm? Yes, of course — but I might be wrong and miss out on the upward move. I have watched investors try to “catch a falling knife” and the results are rarely good. I prefer to use this time of weakness to buy steadily, keeping my average cost down.

That’s my method. What’s yours? I know Uncommon Wisdom Daily readers are interested in gold. E-mail us your practical tips, or maybe an update on coin prices in your area.


Market volume is slow as we wait for the Fed — especially what Ben Bernanke may have to say about “tapering” his QE programs. Tomorrow afternoon should be interesting. Meanwhile, here’s what else is going on …


  • New data from the Commerce Department shows housing starts rose 6.8% in May to a 914,000 annual rate. Economists had expected more, but investors still seemed encouraged to see even a hint of recovery. The report also showed new building permits being issued at the fastest pace since mid-2008.
  • Inflation ran a little lower-than-expected in May. The Consumer Price Index rose 0.1% after falling 0.4% in April. CPI rose 1.4% in the last year.
  • The food portion of the May CPI report fell for the first time in almost four years. We hope grocery shopping will be a little less painful. More evidence: Meat company Hormel (HRL) sliced its profit forecast today, saying refrigerated-food revenues were down.
  • The fight for computer-maker Dell (DELL) is heating up again. Corporate raider Carl Icahn thinks he can entice shareholders with a better deal than the investor group led by company founder Michael Dell.
  • President Obama added to the “tapering” talk last night, as he spoke about the winding down of Ben Bernanke’s term as Fed chairman, which began in 2006. Economists expect Bernanke to step down in 2014. So, even if stimulus isn’t winding down later this year, it sounds like Bernanke’s era at the Fed certainly is!Source:

No gold trader should ignore these odds

Gold traders should never forget that fundamentals are of import primarily for the long-term investor—and nearly irrelevant for the short-term trader.

To be sure, this is hardly an earth-shattering insight, and it applies to all markets, not just gold .

But, like everyone else when markets get overheated, gold traders in recent years became all too prone to overlook it. They were too quick to declare that short-term movements were entirely justified by the GCQ3 -0.01%  fundamentals — so long as the direction was up.

 GCQ3 1,411.80, -0.10, -0.01%



They were thus caught by surprise when gold fell several hundred dollars in just a few days’ time. Since the drop could not be justified in terms of any change in fundamentals, they cried foul. But short-term gyrations — neither up nor down — can never be justified in those terms.

So those crying foul are only half right in contending that, when gold futures fell by more than $140 on April 15 of this year, fundamentals at the close of that day’s session were not appreciably different than they were at the end of the previous session. But the same was true, say, three weeks later — on May 8, to be exact — when gold rose $25 in a single session.

Consider a fascinating recent study published by the National Bureau of Economic Research in Cambridge, Mass. Entitled “The Golden Dilemma,” its authors are Claude Erb, a former commodities portfolio manager for Trust Company of the West, and Campbell Harvey, a finance professor at Duke University. They studied all the fundamental justifications for a gold bull market of which they were aware, looking for any that justified gold’s historical short-term fluctuations.

They came up empty: Regardless of how gold’s fundamental value was defined, they found that gold’s price fluctuated wildly relative to that definition.

Consider, for example, the commonly held belief that gold is an inflation hedge. That’s tantamount to believing that gold’s price remains more or less constant in inflation-adjusted terms, of course.

But that is manifestly untrue: Gold’s real price fluctuates wildly, regardless of the currency in which gold’s price is being expressed. For example, a ratio of gold’s dollar price to the U.S. Consumer Price Index has risen as high as nearly nine-to-one over the last three decades and as low as less than two-to-one.

Note carefully that we can’t wriggle out from underneath this conclusion by arguing that the CPI under-reports inflation’s true magnitude. For example, Erb told me in an interview there has been just a big a fluctuation in gold’s real price over the years when using alternate inflation measures like the one that has been advanced on John Williams’ Shadow Government Statistics website.

The same conclusion emerged when the researchers focused on other fundamental justifications for a long-term gold bull market, such as currency debasement, the threat of hyperinflation, money supply growth, and so on.

If not fundamentals, then what should traders turn to for insight into gold’s short-term movements? The traditional answer, of course, is technical analysis.

Unfortunately, the track record of the short-term gold timers tracked by the Hulbert Financial Digest provides little reason for hope that technical analysis is the answer. Consider their track records, as summarized in the accompanying table.

Last 5 years Last 10 years Last 15 years
% of gold timers making more money than buying-and-holding 8% 0% 0%
% of gold timers with a higher monthly Sharpe Ratio than buying-and-holding 15% 0% 0%
Average annualized gain of all monitored gold timers 3.4% 5.4% 3.7%
Gold’s annualized gain 11.0% 15.9% 10.9%
Average monthly Sharpe Ratio of all monitored gold timers 0.07 0.09 0.04
Gold’s monthly Sharpe Ratio 0.17 0.23 0.16

The results are, to say the least, awful. The best overall record of success comes at the 5-year horizon, and even then only 15% of monitored gold timers have beaten buying and holding gold on a risk-adjusted basis. And even that depressingly low percentage disappears when we focus on longer periods such as the last 10 or 15 years.

Furthermore, as you can see, the average gold timer produces a return that isn’t even close to buying and holding.

The bottom line? Those who invest in gold are on the horns of a big dilemma.

If they decide not to trade, and simply buy and hold gold for the long term, then they must face squarely the daunting prospect of having to live through plunges as big and scary as that seen earlier this year.

And if they decide nevertheless to try their hand at trading, they must instead face squarely the historical odds that suggest they most likely will fail.

We would all rather not be faced with a dilemma both of whose horns are so unsatisfying. But wishing does not make it so.


Stocks Remind Me Of Gold And They Could See A ‘Quick And Painful Adjustment

The S&P 500 ended the week at yet another all-time record high.

Some have tried to compare the current peak to the stock market tops we’ve seen in 2000 and 2007.

However, many — like Reformed Broker Josh Brown — are quick to remind everyone that the comparisons stop with nominal price. Relative to earnings, stocks are clearly much more reasonably priced than they were before the last two market crashes.

This is not to say that there aren’t things we should worry about.

“I am troubled to see that forward earnings has been stuck around its record high of $115 for the past nine weeks,” wrote market guru Ed Yardeni earlier this week. “This is the measure of earnings that I believe drives the market.”

Indeed, this earnings growth stagnation amid rising stock prices have caused valuations to become less attractive.

In a piece for Itaú BBA titled “Developing Euphoria,” hedge fund manager Felix Zulauf raises similar concerns. Interestingly, he draws comparisons between the stock market and the gold market. Here’s an excerpt (emphasis added):

The problem with currently rising equity markets is not rising prices but the lack of fundamental improvement. Stock prices are driven primarily by this lack of alternative investment opportunities and the growing belief that central banks’ money printing can and will generate attractive investment returns for equity investors for a long time despite the lack of supporting fundamentals in the real economy. That is a risky assumption, but as long as rising trends remain intact, nobody worries. In fact, the momentum of the leading equity market indices (Japan, the U.S., Germany and Switzerland to name some) is very powerful and has the potential to carry further, potentially even into a buying climax. Similarities to the gold price in spring 2011 come to mind. At that time, the conviction that gold could only go one way because inflation will eventually rise was as extreme as is now the case for equities.

Once equity markets discover the emperor has no clothes, they could face a quick and painful adjustment to bring markets in line again with fundamentals. For the gold market it was when investors realized there was no rise in CPI inflation or the assumption that systemic risks are declining. It is true that equities look attractive relative to fixed-income alternatives from a valuation point of view, when depressed fixed-income yields are compared to dividend yields or earnings yields (reciprocal of P/E ratios). Those comparisons are all fine as long as economies do not fall back into a recession and earnings stay at least stable. As investors are not expecting a recession, they still believe equities are by far the best place to be, and they act accordingly. That’s why we might see an end to this cycle with a bang (buying climax) and not a whimper (conventional broadening cycle top).