Why the gold bull thesis is wrong on a near-term (3-months or less) and medium-term (6-months or more) basis.
I am and always will be a student of the market, and nothing is more valuable to me than credible, accountable and transparent sources; Keith McCullough of Hedgeye Risk Management taught me that. He has also taught me that contextualizing data is imperative when making investment decisions. The fact of the matter is, that since this past October, the data has been signalling a decline in the price of gold.
The bull case for gold is smartly summarized by Hedgeye as: stagnating/decelerating economic growth leads to further QE initiatives, resulting in the depreciation of the US Dollar, translating into higher gold prices as investors hedge against future inflation and discount further devaluation of the currency.
I am not an expert on gold, but I do study history and listen to data, and I would argue that the risk in gold is to the downside rather than to the upside due to the bullish trend in the US Dollar. The reasons why the US Dollar is strengthening and could continue gaining strength is for three primary reasons:
1) The expectation of further QE by the US Federal Reserve has been obliterated subsequent to the announcement of QE4 infinity. Markets are a function of expectations and fundamentals, and with all of Bernanke’s cards on the table there is no rumor to facilitate further speculative buying in gold. In fact, it is the expectation of a reduction in QE that is currently being priced into gold. Expectation is something that every junior mining investor knows about, it’s the only way we have ever made money. Expectations move markets.
2) Funds from around the world are flowing to the US. The most dangerous bubble is upon us, and that is the global Cash Bubble; Ray Dalio of Bridgewater Associates (the largest hedge fund in the world) speaks to this point often: “The returns of cash are terrible. So as a result of that, what we have is a lot of money in a place – and it needed to go there to make up for the contraction in credit – but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift.” Fund flows are the most important factor to consider in a Cash Bubble. Where will they go? Year-to-date the SP500 is up + 13.3%, Gold is down -12.3%. Make no mistake about it, the US Federal Reserve is in the business of manufacturing bubbles (Tech, Real Estate, Commodities). The only way to maintain the largest debt bubble in the history of mankind is to move on to the next one.
Every mini crisis, whether it’s the Italian Election or Cyprus, sensationalized by the media creates further momentum for funds flowing to the US. We live in a very inter-connected world, and data and trends need to be put into context and evaluated relative to what is going on elsewhere. To say that because the US Federal Reserve is monetizing $85b a month in US debt is why gold is on a path upwards is incorrect. Investors must contextualize the data and understand that the expectation of Europe and Japan’s relatively dovish fiscal and monetary policies, and relatively weak economies, is bullish for the US Dollar. The question to ask is: Where is the relative strength? In addition, gold does not have the capacity to facilitate the shift Mr. Dalio speaks of; there is simply too much liquidity that has been created and it has to go somewhere that can accommodate it. 2013, thus far, is an indication: US Dollar +2.3%, SP500 +13.3%, Gold -12.3%, Silver -20.7%, Brent Oil -6.2%, Corn -6.1%, Copper -10.7%. Numbers do not lie.
3) The US economy is improving on the margin as Consumers benefit from commodity deflation. The deflation of commodities is not a result of growth slowing, it is the catalyst for growth stabilizing. If you think the former you are operating on an outdated playbook. Hedgeye has been strong on this theme. As Keith McCullough points out regularly, correlations are not perpetual; study history. Inflation is not growth, it impedes growth, and at a point central bank engineered bubbles become the enemy of global economics via price distortion. The bullish case for US Equities continues to gain strength because a strengthening US Dollar empowers the consumer. The US economy is greater than 70% consumption based and less expensive food and gas is an immediate tax cut. The further commodities deflate the more US consumers can afford to spend, and they are. What is being reduced is US government spending, which, on the margin, is US Dollar bullish; again, context.
The behavioral finance perspective behind all of this, and as George Soros has expressed time and time again, is that markets are reflexive and people chase price, which will only add further momentum to the case for US Consumption stocks and US Housing prices. If Mr. Soros is correct, there is a tsunami of cash that could participate in this race to the US, and specifically, to US equities.
The predominant Global Macro themes for 2013 year-to-date have centered around understanding the causal impact of central planning on their domestic currencies. “Get the central plan right, you get the currency right. Get the currency right, you get the correlation right. Get the correlation right, you get the money.” (McCullough)
Where is the bottom in gold? I don’t know, but I’m not in the business of catching a chainsaw, and I know that price is not a catalyst. Why call a bottom in Gold with the US Dollar in a bullish trend? Why call a bottom in gold when both the economy (on an inflation adjusted basis) and employment in the US are strengthening on the margin? I don’t know how this all ends or even if it ends well, but I will let the market tell me what to do next. If the US Federal Reserve decided to expand its QE initiative tomorrow I would re-evaluate my position and change my mind if the data was compelling enough to do so. If systemic risks emerge, whether due to European sovereign debt concerns or a crashing Yen, I will do the same. But hope is not an investment thesis. I will change as the market changes, it’s a less stressful way to live.
“To improve is to change; to be perfect is to change often.” – Winston Churchill.
Alim Abdulla is an Investment Advisor at Leede Financial and is a co-founder of the Trading Analytics Group (TAG). He has been with Leede for nine years and began his career in the Financial Industry a year prior at Canaccord Capital. Alim considers himself to be an Active Risk Manager focused on long/short equity portfolios.
Disclaimer: The comments and opinions expressed herein reflect the personal views of Alim Abdulla. They may differ from the opinions of Leede Financial Markets Inc. and should not be considered representative of the research beliefs, opinions or recommendations of Leede Financial Markets Inc. The information included in this document, including any opinion, is based on various sources believed to be reliable, but its accuracy and completeness is not guaranteed. Member CIPF.