September 6, 2008 – Is the Gold Bull Dead?

Two weeks ago I talked about Obama and Biden. Last week I talked about Obama, McCain and Palin. While I think an understanding of the political situation is important to an understanding of our investment prospects, this is a blog about the stock market, not about politics, so you will be happy to learn that today, other than this first paragraph, I’m not going to talk about politics. Perhaps I’ll start another blog where I can espouse my political views. Here’s the kind of thing I would write, if I had thought of it: Penn’s commentary on CNN.

Now, to the more important issue at hand: The Markets.

Needless to say, it hasn’t been a good year.

Our friend Mr. Dines, in his IWB yesterday, started off by saying: ” Everything is down, there has been no way to hide amidst a
suffocating blanket of bad news, so good riddance to this summer.”

Yup, that’s pretty much it. The summer really sucked. Too bad most of the Dines stocks were on “Buy” signals all summer.

Not that any of the other “experts” have done any better. Readers of any of the Casey Research newsletters will know that all of their stocks have been hammered as well, so it’s been a bad summer all over.

Why have all of the experts been wrong? There are many theories.

The most obvious explanation for the weakness in gold, uranium, and other commodity stocks is that the credit crunch squeezed everyone. To meet margin calls, and to raise cash, everyone has been selling everything. In fact, when trying to raise cash you sell your most valuable assets, since those are the only assets that can be turned into cash. If you are a hedge fund, you don’t sell your mortgage portfolio, since there are no buyers; instead, you sell your gold, your resource stocks, and the like. With all of that selling, everything goes down, and goes down by more than anyone expected.

The other theory, of course, is that the market is heavily manipulated.

On July 15 the SEC suspended the shorting of various bank shares. Why? To prevent those share prices from collapsing.

And, to complete the picture and to show that the financial markets are sound, gold needed to be knocked back. Follow me on this one: everyone knows that gold is what you buy in troubled times. If the price of gold is going up, we all have proof that times are bad. But, if the price of gold is falling, we think the crisis has been averted, and good times are back.

Gold Three Year Chart

The price of gold rose steadily, from $450 per ounce in the fall of 2006, to $800 last fall, to over $1,000 in March of this year. Bad times indeed, and the rise in gold coincided with the problems with sub prime in the financial system. But then:

Gold 3 Month Chart

From the middle of July, over a five week period the price of gold fell, almost every day, from the $980 level to $780, a stunning drop in five weeks. (The $780 level appears to be holding, for now).

It’s almost as though the Big Boys decided to shore up the system by buying bank stocks and the US Dollar, and shorting gold. In the short term, it’s worked brilliantly, and the suckers out there will look at this action and say to themselves: “The worst is over; bank stocks look good, the US Dollar looks good, commodity stocks look bad, so I’ll sell my gold and buy my bank.” This will probably be the last chance the Big Boys get to unload their crappy bank stocks, and that’s what they are doing. For proof, compare the 3 month gold chart above to the three month US Dollar chart:

US Dollar 3 Month Chart

As the US Dollar has increased, gold has fallen.

I’m not buying it. This looks like a pre-election “fake out” to strengthen the dollar and make everyone forget the underlying problems in the economy.

Why am I so sure that this is a “fake out” in gold, and not the beginning of a new bear market? Because reality tells a different story. It’s one thing for the Big Boys to start shorting gold contracts, but it’s another to effect the underlying markets long term. The facts are simple:

First, the US Mint had to temporarily stop selling Gold Eagle coins, because they had run short on physical gold. It’s probably because in the first six months of this year they’ve sold 50% more ounces of gold coins than they sold in all of 2007. The Canadian Mint has also slowed down shipments of Canadian gold coins.

You can manipulate the markets for a week, or a month, or maybe even six months or a year, but if there are shortages of physical gold, the price will go up. It’s called the law of supply and demand, and there is nothing, ultimately, that the Big Boys can do about it.

Nothing.

Second, I believe the economy is in far worse shape than is generally known. We have weathered the “sub prime” crisis, but there are lots more crisis to come. What the banks did with sub prime mortgages, they have also done with other financial vehicles, like credit cards. What will happen when the rate of credit card defaults ramps up?

And the real estate mess isn’t over yet. The word on the street is that nearly one in three people who bought a home since 2003 are now in a negative equity position. That means if they were to walk away from their home and default on it, they really have nothing more to lose. That’s scary.

I spoke to a car salesman this week. Last August he sold 21 new cars. This August he sold 10. Dealer incentives at the Big Three automakers are virtually gone. Last year it was all zero percent leases. Now, leases are hard to find due to the shortage of capital, but they will loan you the money to buy the car at 12%. That’s a massive change since last year, so it’s no wonder sales are down.

If the auto industry is depressed, and if real estate is crashing, what’s left? The consumer is hitting the debt ceiling, and that means a long recession. But there’s an election coming, so the government will continue to print money to hold off the worst of the bad news until November, and then it’s all down hill from there. The dollar will resume it’s crash, and gold will have no where to go but up, due to the inverse relationship noted above.

Call me a pessimist, but I don’t like the looks of the world right now.

So, what’s my plan:

First, I will hold high quality producers. It will take the junior speculatives a long time to recover, so I will leave them to someone else.

Second, I will hold some cash, so that I’ve got some for the inevitable buying-opportunity-after-the-crash opportunity.

Third, I may investigate buying a few gold coins and putting them in a safety deposit box somewhere, since the price is very cheap now.

Fourth, I will continue to avoid margin. I haven’t used any margin in the last year, and I don’t plan to start now. Times are too volatile to magnify my losses.

Finally, I’m not going to panic. There is no point in selling the quality producers now, near the bottom. Even if we have further weakness, I can’t time the bottom, so I’ll hold, and not watch each stock every minute of every day.

We had 475 new posts on the the Buy High Sell Higher Forum in August, the most ever, and much higher than the 286 in July, so action is heating up, so keep sharing your thoughts as we all struggle through the fun times ahead, and thanks for reading and contributing.