Gold's taken a downturn recently, but is it a blip on the radar or a fundamental shift in the market?
Not surprisingly, gold’s steep correction has generated some concern for
resource stock investors. So let’s take
a look at the gold market.
I figure the metal "should" be worth something like $1,000 an ounce
now to be in a rough equilibrium with the value of other things the dollar can
buy. That’s an arbitrary guess; there’s no exact method I know of to determine
gold’s real dollar value. If the U.S. dollar were sound, there would be a fixed
amount of gold in the treasury for every dollar in circulation; in the 19th
century, a $20 note was a receipt for an ounce of gold held on deposit, and a
"dollar" was just a convenient name for a 20th of an ounce of gold.
Today, of course, the relationship between the dollar and the amount of gold
the U.S. Government has to redeem it with is so tenuous that it’s completely
academic. But, assuming that the government were just to make good on dollars
held by foreigners—forget about Americans—how high a gold price might be
First we need to know how many dollars are outside the U.S. Nobody knows
exactly. They constitute the reserves of most foreign central banks and the
de-facto currency of record in dozens of countries for ordinary citizens. The
amounts are almost beyond belief; it’s said that, in Moscow alone, there are more US$100 bills
circulating than in the entire U.S. Could $5 trillion be the number? If so, and
if there are the reported 261 million ounces in the U.S. Treasury, the value of
that gold comes to about $20,000 an ounce. Just to make good on the reported U.S. trade
deficit of $800 billion for the last year, we’re talking $3,000 gold. Forget
about what the numbers would be if you added in the domestic money supply, M-3.
Especially since they don’t even publish it anymore.
But the numbers, at this point, are academic. My basic view on gold is
unchanged. And the fact it had a 37% gain this year, reaching a peak of $725 on
May 12, or has given back 22% since then is meaningless in the big scheme of
things. As I’ve said before, before this market is over, gold isn’t just going
through the roof; it’s going to the moon. And the market is by no means over.
It’s just starting to wake up from a generation-long slumber.
Why did it heat up the way it did? Perhaps the attention of the traders was
drawn to gold by Bush’s brinkmanship and buffoonery over Iran. Perhaps
it was people noticing that gold was a relative laggard among the metals in
this bull market. Perhaps the market was paying more attention to the Russians
and the Chinese, among others, divesting dollars. There is solid evidence that
dehedging by the producers helped fuel the surprisingly strong rally, and that
that dehedging is now slowing.
Likely it was a confluence of these and other factors. Thousands of hedge
funds, most of which collect their 20% profits just to follow the trend, piled
in. As the herd took their positions—especially when the short-term oriented
traders had all bought—momentum slowed, and it went into reverse.
Remember that most of these traders were toddlers the last time gold got
anyone’s attention, back in the 1970s, and so they only know what they’ve been
taught—that gold is an anachronism, a valueless relic. Consequently, they have
almost no understanding of gold’s fundamentals.
Consider, for instance, a primary reason given for gold’s big correction is
that higher interest rates will make gold a less attractive asset. As if there
is some hard and fast rule that says gold can’t move up when interest rates are
rising. But that ignores the clear historical precedence of the 1970s when
interest rates were surging at the same time as gold.
It’s unwise to try picking tops and bottoms in the market. But, the way I see
it, gold has made its bottom as you read this. The fundamentals haven’t
changed; there’s only been a swing in traders’ sentiments.
As for the gold stocks. We’re still in the “Wall of Worry” stage of the market.
The larger public is not involved, and the thin slice that is, is just moving
with the price of the metal. The downdraft has been aggravated by the weakness
in the NY market. Remember, gold stocks do best when both gold and stocks are
rising and worst when both are falling.