My Apologies For Gold, And More

by JDH on October 10, 2009

My apologies. No, this is not my David Letterman impersonation; I discussed David Letterman last week, and I have no plans to discuss him again this week. Yes, it is clear that the combination of a 60 year old man and an endless supply of Viagra is a dangerous combination, but that’s not what we are here to discuss. However, since Letterman’s ratings have been way up since he started apologizing, I thought I would give it a try and see what happens. Since I’ve never tried Viagra I can’t apologize for those indiscretions. Instead, I have to apologize for screwing up the gold market.

You see, last weekend, I started reflecting on the gold market, and the market in general. I began to worry that a sudden correction, organized by the Big Boys, would crash the market, and I would be setting myself up for another down year. I would feel really stupid if I spent most of the year in cash, and then at the very end of the year got heavily invested, only to see it all evaporate. If I had been all in all year I’d be way up, but I’ve been mostly in cash, so I’m only marginally higher, and I don’t want to see it all disappear now.

So, on Monday morning, I began liquidating my gold and silver stock holdings. In fact, if you look at a chart of the spot gold price on Monday, you can see where I started selling:


Yes, it appears that my sell orders were the exact start of the rally in gold, that lasted from Monday through Thursday, before a slight pullback at the end of the week. So, my apologies for single-handedly causing the gold market to rally. If you wanted to buy gold at a good price, this was not the week to do it.

Should I be worried about gold? Perhaps not. My perception at the moment is that we have had a big run up in gold, and a decent increase in gold shares, so a pause is likely. That’s why I’m planning to be 85% in cash for the balance of the month, which is where I am now.

The alternate viewpoint is that gold is just starting it’s run. Thank’s to punter over on the Buy High Sell Higher Forum for providing a link to an October 8 article by Puru Saxena, who said quite simply: Buy Gold. He makes the compelling argument that we are in the early stages of this run, and as evidence he offers this chart (which I am stealing; you can see the original chart here):


As the chart clearly shows, the price of gold built a base for ten months up to September 2005, then broke out. The next base building ended in September 2007, and the most recent consolidation has ended with a break out to new highs in early October, 2009.

The chart is compelling, but of course beauty is in the eye of the beholder, as are resistance lines.

The 2005 consolidation range was from around $410 to $450, or a spread of about 10% bottom to top. The breakout carried gold to about $725, for a pop of over 60%.

The 2007 consolidation range was from around $575 to $725, or a spread of about 25% bottom to top. The breakout carried gold to over $1,000, for a pop of about 38%.

The 2008 to 2009 consolidation range was from around $700 to $1,000, or a spread of about 43% bottom to top. A breakout of 50%, which is about the average of the last two break outs, would take gold to over $1,500 over the next six months.

The break out phase in the last two runs has also had RSI levels over 70 for extended periods of time, which is unusual, but not unheard of during the “mania” phase.

So, are we at the “mania phase”? Nope. Not even close. Allow me to demonstrate.

I occasionally conduct an experiment where I travel from my little corner of southern Ontario to the big city, Toronto. I go to the Bank of Nova Scotia, now calling themselves Scotiabank, at Scotia Plaza, their head office in the heart of downtown Toronto. I’m sure you all recall the report of my last visit in October 2008 (if for some unknown reason you have forgotten, you can refresh your memory with my Circling the Bowl post of October 11, 2008, almost an exact year ago from today). Here’s what I said a year ago:

While I was in Toronto on Wednesday, I stopped by the precious metals desk of Scotiabank at Scotia Plaza. As I reported in my thoughts on gold last week, it’s hard to find any metal to buy, anywhere. Scotiabank is the largest precious metals dealing bank in Canada, so if anyone would have anything, they would. I asked to buy some silver bars. They had none. Nothing. Zip. One ounce, 1,000 ounce, all the same: nothing.

In my quest to actually buy some physical gold or silver, I asked for 100 silver Canadian Maple Leafs. With silver in the $12 per ounce range, I didn’t think a purchase of $1,200 worth of silver would be a problem. It was. I could only buy 25 coins. That was it. The biggest bullion and coin dealing bank in Canada, at their main branch, on top of their main vault, could only offer me a few hundred dollars worth of coins. I took them, although it’s such a small quantity that I’m not sure it was worth the bother.

They did have some gold Maple Leafs, but I’m still shocked at the shortage of silver.

So how did my trip go this week? Much better. I asked to buy 100 one ounce silver Maple Leaf coins, and they said no problem. I asked if they had any gold Maple Leafs; also no problem. I was there as gold was making a new high. There was virtually no line up. I asked the clerk if they had been busy, and he said no, nothing out of the ordinary. Therefore, I conclude that despite a record high price, we are no where near a mania. Residents of India and China own gold, but in Canada, and the U.S., physical gold and silver ownership is no where near a main-stream pursuit.

Now, here’s the interesting part. The actual price, to purchase an actual one ounce gold Maple Leaf, in Canadian dollars, including commissions, and 8% Ontario Sales Tax, were as follows:

  • October 8, 2008: $1,181.33
  • October 7, 2009: $1,306.91

That’s a gain of 10.6% over the past year.

Again, I must apologize, because when you look at the chart of gold over the last 14 months, the up trend is deceiving:


The peak in late October, 2008 (just after my visit to Scotiabank) was around $940 U.S. per ounce. By mid November the price had temporarily crashed to below $700 per ounce, and we didn’t see $940 again until February of this year. Gold is very volatile. Prices go up, and prices go down. A gold coin may be worth 10% more in Canadian dollars today than it was a year ago, but it could easily have dropped by more, or gone up by more, depending on when the purchases were made.

Last October was the peak before the crash. History could repeat itself again this year. Or not. The RSI and MACD are not at the same levels, so anything could happen.

Incidentally, here are the comparable prices to purchase an an actual one ounce silver Maple Leaf, in Canadian dollars, including commissions, and 8% Ontario Sales Tax:

  • October 8, 2008: $19.87
  • October 7, 2009: $25.93

That’s a gain of over 30% over the past year. Clearly the shortage of physical silver last year lead to a big run in the price of silver, so silver outperformed gold by a wide margin.

(As an aside, you can read more on the How to Buy Physical Gold page on this site).

History is great, but what now? The conundrum: gold has run from less than $700 to over $1,000 in less than a year. A 40%+ run is a huge run, and profit taking, like we saw last October/November, is not uncommon. On the other hand, gold just made a new high, so the “buy high sell higher” theory is to buy when a new high is made, since there is no overhead resistance.

I must admit that I am confused. A pullback seems inevitable, but I don’t want to be on the sidelines for a major move to the upside? Do I err on the side of greed, or fear? The answer:


I am up marginally this year, which is a much better performance than last year, or the year before. I could go to cash now and sit out the rest of the year, and be satisfied that I didn’t lose anything.

My fear stems from the fact that the market in general, by any rational measure, is extremely over-valued. The trailing PE multiple on the S&P 500 is over 27, which is a massive 10 point increase from the lows in March. Usually we don’t get a multiple that high until the recovery has been going for three years. According to David Rosenburg, Chief Economist at Gluskin Sheff:

Going back 60 years, there have only been 14 months when the trailing multiple was as high as it is today, and that covers 10 recessions. This implies that the market is in the top 2% expensive terrain historically, and those other times basically covered the tech mania of a decade ago.

Yikes. The market today is as over-valued as it was just before the tech bubble burst. Here’s more:

Never before have we seen the S&P 500 rally 60% over an interval in which there were 2.7 million job losses as is now the case. What is normal is that we see more than 2 million jobs being created during a rally as large as this.

A recovery when we are still losing jobs? That doesn’t make sense. How can the market be up when unemployment is high? Consumer debt is at record levels. Bankruptcies are at record levels. The fundamental economy is in bad shape, and that’s not good news for the market. I can only assume that government stimulus money has found it’s way into the market, and those funds are artificially propping up the market. If those funds dry up, so does the market advance. (Which, incidentally, is exactly what happened to new car sales. The “Cash for Clunkers” program caused a huge blip up in sales, but now that the program is over, new car sales in the U.S. have crashed again. Not exactly a sign of a recovery. “Ups” only happen when government money is involved).

I also worry about the world in general. There will be much discussion over the next few days over the fact that President Obama received the Nobel Peace Prize. Nominations for the prize ended two months after he took office, so he is being awarded the prize for “hope.” I agree that talking with your enemies is a better starting point than going to war with them, and hopefully two or three years from now he will have done enough to be a worthy recipient, but for now all he as done is defeat George Bush. That’s it. He will be increasing troops in Afghanistan, the war in Iraq continues. Peace has not broken out in the Middle East. Violence continues in Chicago. None of those problems are Obama’s fault, but he also can’t take credit for solving them.

It appears to me that the international community is telling Obama “stop the war”, but it’s not that easy. America spends more on defense than almost every other country in the world combined. Stopping the wars tomorrow would cause massive unemployment as the soldiers returned to America, and the defense industry would collapse. If it was up to me I would withdraw and stop the wars tomorrow, but life isn’t that easy.

The shine is fading from the Obama rose, and I fear that an increasing number of Americans will start to say “wait a minute; he has yet to accomplish anything; foreigners love him, but they also appear to be manipulating him; they give him the Peace Prize so he will do in Iraq and Afghanistan what the foreigners want, not what America wants; we don’t want a puppet in the White House.” Fridays have not been good to Obama. Two Friday’s ago he lost the Olympics. This Friday he got stuck with a Peace Prize he knows he didn’t deserve, but he didn’t have the where-with-all to simply refuse it. What’s up for next Friday? A stock market crash?

My apologies again. I digressed. I’m a Canadian, so what happens in the White House is of no direct concern of mine. I just worry about the impact on the markets. So, back to the markets.

I must apologize again, because of course I have been wrong all year. I expected a correction, and it hasn’t happened. Over on the Forum Gonzoo asked the question “What Should I Do?” He’s up for the year. Sunseeker and jjj000, who are both also up on the year, replied that you can let your profits run, or be prudent and take some profits. I congratulate the three of year for having the guts to be in when I was out; you should probably be writing this weekly blog. Having said that, if I was up by 100%, I would be cashing in and going to cash. Profits are nice, so take them.

Here’s my prediction: gold and silver will increase dramatically in value, and by next year, or two years from now, they will be substantially higher than they are today. But, with each passing day the chance of a general market correction becomes greater. We all remember the big run up in uranium stocks in 2006, and the subsequent cash. Fundamentally uranium is still necessary, and long term it will be higher. But in the short term anything can happen.

So, I am moving to cash, with one caveat: On Tuesday I will consider buying some insurance, in the form of options.

For example, let’s say I sold 1,000 shares of AEM.TO – Agnico-Eagle Mines Ltd. at $75 this week. That brought in $75,000 in cash. I could buy some December 82 call options for just under $3. It would therefore cost me $3,000 to control 1,000 shares.

If I hold 1,000 shares and the shares drop by $10, I lose $10,000. If I hold options, I get wiped out and lose $3,000.

If the shares go way up by $10, my shares increase by $10,000. The options go from $3 to $10 (assuming over this time the time premium is eroded to nothing), so I make $7,000.

So by holding options I only risk $3,000, but I could make $7,000. Are those good odds? I haven’t decided yet. Those of you with more expertise in this area can let me know. Perhaps I pay more premium but by options farther out, say next March, but which time the correction should be over, so I don’t lose the time premium either.

I will probably just decide to stay 85% in cash and keep my life simple, and hold some shares for possible upside.

My final apology today is for this long winded dissertation; thank’s for staying until the end. Feel free to post your comments, whether you agree or disagree, on the Buy High Sell Higher Forum. Thanks for reading, and for my fellow Canadians, enjoy the day off on Monday for Thanksgiving.