Get On Board The Gold Train, Next Stop $1,800 By Scott Redler |
December 07, 2010
Gold has been one of the stories of the
market over the last several years as the global economic
crisis and an overall lack of trust in the “system”
has led investors to seek a more evergreen store of value.
I personally first began talking about Gold
in December 2008 when it was trading at $850/ounce. I felt
the technical indicators and a compelling story suggested
a move to $1,300-$1,500. Although I did not hold the SPDR
Gold Trust ETF (NYSE:GLD), which is my preferred vehicle
for trading gold, for that entire run, I traded gold on
several occasions within that time frame with much success.
When
you have a powerful idea, you must be able to execute it
in a way that fits in with your overall trading or investment
strategy, and that’s what I have done with gold. In
hindsight, do I wish I had bought tier four gold in 2008
after I made that prediction on CNBC, and held it for the
entire measured move? Sure, but I have not lost any sleep
over it. I feel content that I traded gold in a way I was
comfortable with. I have applied my own active, risk averse
approach to the gold trade, locking in gains and taking
risk off when it seemed appropriate to do so. Depending
on your overall strategy as a market participant, customize
your approach to trading gold.
How the gold trade has evolved
While the basis for most of my trading decisions
comes from strict, prudent technical analysis, there has
also been a powerful story to tell about gold apart from
the charts.
Curtis Hesler told his readers to back up the truck and
buy Silver Wheaton (SLW) at $4 in late 2008 and Goldcorp
(GG) at $18. Sell here or buy a bunch more? Click here for
instant access to updates in Professional Timing Service.
Over the course of the last several years,
the nature of the gold trade has evolved. Back in 2008,
when the price jumped from $850 to $1,000 an ounce, it was
the “fear trade.” Amid the global panic of the
credit crisis, investors wanted to own something tangible,
something they could touch and feel. Gold was seen a safe
haven.
Then, in 2009, the gold trade morphed into
the “inflation trade” as the world recovered
from the depths of the historic recession, as I noted on
CNBC in September 2009. As governments raced in to save
the day and print money to rescue institutions, investors
feared the implications of the newly minted “too big
to fail” paradigm. During that time, the reverse head
and shoulders pattern formed, sending spot gold from $1,000
to $1,224/ounce.
In 2010, gold shape-shifted once again into
the “sovereign debt trade.” Fears of contagion
in the Eurozone debt crisis have engendered calls for the
end of the Euro and even the European Union. As the year
has gone on, the crisis has worsened. Ireland recently joined
Greece as the first PIIGS to require a massive bailout.
Doubts about the future of the Euro have sent gold from
$1,265 to as high as $1,400+ an ounce.
Where are we now?
Now,
with 2010 getting closer to the rear view mirror, it’s
time to start looking forward to the next leg of the journey.
What will gold look like in 2011 and beyond? Well, all indications
are that the European sovereign debt crisis will get worse
before it gets better. A massive bailout for Portugal seems
almost inevitable at this point, and then we start getting
into the real big kids on the block. A bailout for Spain,
the ninth largest economy in the world, might require more
money that the system could tolerate. If a domino of that
size were to fall, who knows what could be next to follow?
Many people judge “bubbles”
and over-hyped phenomena in the financial world based on
when the retail public take notice en masse. Conventional
wisdom now says that when the retail public starts hearing
the story and jumping on the bandwagon, a top is imminent.
With cash for gold ads polluting our television screens,
gold vending machines popping up around the country, and
gold stories starting to populate the covers of mainstream
magazines, it certainly feels like the gold story fits the
bill. However, it would be fallacious to blindly judge something
only on such a basic level without digging deeper. Each
case study, when you are presented with a framework, must
be reasoned based on its own merits. In this instance, I
believe the facts supporting another surge higher in gold
prices outweigh the doubts accompanying this analogy.
There is no substitute for the real
thing. The equity market rally could be fool’s gold.
Even without the worst case scenario coming
to fruition, gold seems destined to go higher as long as
fear remains a part of the equation. Over the last couple
months, as the market trudged ever higher, we were lulled
into a sense of complacency. The market, once ruled by headline
risk and overnight moves, had become more focused on earnings
and valuations, but that doesn’t mean things couldn’t
return to what they used to be.
The rosy complexion of the market was driven
largely by expectations that the Fed would prop up asset
prices at every turn, and it could be argued that prices
are artificially inflated at current levels. The Fed has
taken a “fake it until you make it” approach;
continue to prop up asset prices until the economy picks
up. If it doesn’t work, at what point are QE3, QE4
and QE5 no longer an option? Over the last week or so we
have seen headlines reassert their power, with the Ireland
debacle and the Korea skirmish serving as a stark reminder
of what can happen. Tinkering with asset prices causes price
instability, and investors will not be so quick to fall
into the same old trap.
Inflation: There is also
the giant elephant in the room: inflation. Many argue that
we are currently in a strictly deflationary environment
that needs to be fought at all costs, and that if real inflation
does appear, the Fed has tools to fight it. Government officials
still claim there is no inflation, but as food and gas prices
skyrocket around the world, consumers are scratching their
heads over such an assertion. We have also seen “shadow
inflation”, which can be understood as value deflation.
Instead, for example, of getting a 7-ounce bag of coffee
beans at Wal-Mart, you can now only get 6-ounce bag that
costs the same price, a fact that is not taken into account
in the Consumer Price Index (CPI). While a gym is cutting
costs or keeping fees stable, for example, they are getting
rid of water fountains and turning off the air conditioning.
In general, the average investor has grown skeptical of
our already discredited leadership.
Nassim
Taleb, a renowned expert on understanding black swans and
left tail risk, describes the potential hyperinflation phenomenon
as trying to get ketchup out of the bottle. Upon the first
couple of smacks, little-to-nothing might come out. Smack
the bottom of the bottle three or four more times, though,
and the whole contents might end up on your plate. The Fed’s
QE program is arguably the biggest science experiment of
all-time, performed with taxpayer money, and the end result
is unclear. Even Ben Bernanke admits that he does not know
what the outcome will be given the complexity and ground-breaking
nature of his Fed’s bold actions. For all we or they
know, all this money printing and monetization of debt could
be setting the stage for a period of high and difficult-to-fight
inflation. It remains to be seen whether, at that stage,
the Fed would have the credibility or the tools to combat
runaway prices.
All Likely Scenarios Point to Higher
Gold Prices
If all-out disaster can be averted in Europe,
and the U.S. economy can continue to grow, gold can still
see a slow technical grind to $1,600-$1,800. If Europe starts
to falter even more (remember, debts come due over the next
several years), which seems likely at this point, gold can
really go parabolic to $2000+. We are heading toward an
environment in which nobody feels comfortable holding any
fiat currency.
Gold, something that cannot be conjured
out of thin air and has universally recognized value, would
be seen as the primary store of value. Other precious metals
like silver, which has outperformed gold handily this year,
would likely behave in a similar fashion. The U.S. mint
has seen a dramatic rise in demand for silver eagle coins,
with sales up 30% since 2007.
The two most likely scenarios for the world
economy both offer strong support for higher gold prices.
Further deterioration in Europe and the US would trigger
an exodus from fiat currencies into gold, and a high-inflation
recovery would send gold prices soaring. Gold is both a
safe-haven play and an inflation hedge. The only scenario
where gold could burst like a bubble is if, against all
odds, the economy recovers, budget deficits self-correct
as aggregate demand and tax revenues soar, the Fed is able
step in to stem the tide of high inflation at just the right
time and the world presses on into the 21st century like
this little recession never happened. Sorry folks, but I
just don’t see that happening.
State Debt Crises: The Story of
CAIN and (Un)Abel
In Europe, they were able to come up with
a clever moniker, PIIGS, to succinctly represent the most
boorish animals on the farm, and its only appropriate the
for us Americans to come up with our own distinction as
state budget crises becomes more pressing.
I
am going to call it the story of CAIN and (Un)Abel. CAIN
represents seven of the most rotten pillars of our union,
the states with the most urgent budget concerns–C
(California), A (Arizona, Alaska), I (Illinois), N (New
York, New Jersey)–while (Un)Abel describes the country
as a whole. (Un)Abel, as in unable to do anything about
the impending crisies. Given the current political climate
and implicit anti-bailout mandate of the new Congress, the
Federal government might be powerless to do anything but
accept painful state defaults. Before we know it, we could
all be ancestors of evil.
In April, Congress plans to meet to discuss
debt levels, which will include how to deal with individual
state crises. Keep in mind, this is the same Congress that
has been recently restocked with (supposedly) debt-conscious
Republicans who will (presumably) feel obligated to put
their foot down on further massive government spending.
The possibility of further deficit spending appears remote,
if not dead-as-a-doornail. It just so happens that 2011
could be the year that CAIN starts to face some serious
trouble, and may need some serious help to avoid killing
his brother (Un)Abel.
If large state dominoes start to fall and
creditors are forced to the table, it could lead to rehashing
of the widespread fears from 2008. California, after all,
is the fifth largest economy in the world, and would be
a mighty large domino. The non-partisan Legislative Analyst’s
Office projected on November 10th that the budget shortfall
in California will be $25.4 billion, twice as large as state
political leaders had predicted and more than a fifth of
the general fund. A default by a sovereign state (and it’s
biggest, at that) would affect the credit rating of the
United States as a whole. A bailout, if it were approved,
with deep cuts for pension holders and other programs would
likely be met with angry demonstrations by Californians,
much like we have seen in Greece, Ireland and across Europe.
Civil unrest would do wonders for the price of gold. As
Chris Whalen stated earlier this month, this entire situation
amounts to a Federalist crisis for the United States. These
issues are not limited to California.
What to do with gold
Gold has a compelling long-term story for
higher prices, but what is the best way to approach the
trade? For an active approach, you could be long tier one
here versus current support of $1,310-1,330, which would
be the technical stop-loss on the trade. If nothing else,
investors should consider having gold and/or other precious
metals as a portion of their portfolio as a risk protection
against the possibility of further deterioration of the
world economy and high future inflation. We will be looking
for more calculated technical areas to potentially add further
tiers of gold for the next macro move.