Monday, September 15, 2008

Gold Tsunami II: Anthropomorphizing Gold

15 September 2008

I wrote recently that there is a tsunami coming in gold.

As a long-term gold investor, it never crossed my mind that gold would retreat to the levels it has recently. Think $739.80 on September 11, 2008 - down almost $300 from its (modestly valued) March 17, 2008 peak of $1033.90. And... as Marc Faber and the Adens have done, let's not discount the possibility that gold could decline further in a global liquidity freeze-up, say to the $600 level (though not in a straight line down).

If this occurs, it will constitute a primary correction - a critical concept that all gold investors need to understand, though this idea is rarely discussed, even in the gold community. I credit Ed Bugos (now the gold small cap advisor with Agora Financial) with defining the concept of the primary correction, and giving it the attention it deserves.

Mr. Bugos has suggested that such a correction would be likely to occur in response to a blow-out top in gold combined with a meaningful bottom in the stock market - as took place in 1975. This pattern has not so far recurred in the present gold bull market.

Gold's recent gains and pullbacks - until the current one, have been modest events, with corrections in the 20% range or less. When gold corrected in 1975, it fell from 6 times its previous level to 3 times its bull market entry level. Today, we would need gold values in excess of $1500 to re-create such a scenario. Also, the 1975 pullback was much more gradual than the current one. So it is difficult at many levels to liken the current events to 1975.

In 1975, 6 years into its 1969-1980 bull market, gold fell below its long-term supportive 65-week moving average and retrenched at levels as low as 50% of its peak value for 1-1/2 years. At present, we have seen a price fall of almost 30% over a 6-month timeframe. If this is a primary correction, it could certainly persist another 6 to 12 months, and a fall of another $200 in gold's market price would be imaginable.

But that would make this a highly atypical primary correction!

By Mr. Bugos' very sophisticated criteria (I hope I am interpreting him correctly), the recent sudden collapse in the gold price constitutes an over-reaction moreso than a probable primary correction. If he is right, then we will see recovery in the gold price when it becomes clear that the Fed is holding the course on its now long-term super-inflationary policies, and the primary correction will lie somewhere further down the road - following an excess of favourable popular sentiment towards gold - and gold mining stocks!

Take it from someone who has been invested in the gold market since mid-2003, the idea of gold investing has not so far come even close to capturing the broad public imagination, as would be required in the case of the primary corrections of the past. The halls of the gold investor conferences are again deserted. The exhibitors can't even afford to fly out representatives to man the information booths. The current gold bull has had periods of exuberance, but has not so far begun to show excessive froth in its 7 to 8 years to date!

If you'd like to know more about the concept of the primary correction, and gain access to Mr. Bugos' incisive gold market investment advice, click here to register for his advisory service.

Fundamentally, the continuing collapse in gold's market price makes no sense at all at this moment in time - though technically, we all know that investments need to test and retest price support levels of all kinds, including those that reside at lower levels than make us comfortable. The problem is that all asset classes are at risk - even gold - when investors have falling amounts of cash to deploy.

As I post this blog, Wall Street has now lost three of its five leading independent brokerages. Lehman Brothers (once an Alabama-based cotton brokerage, and now in Chapter 11) is being broken up to feed the vultures, and Merrill Lynch is being acquired by Bank of America. Bear Stearns is already long gone. Fannie Mae and Freddie Mac have just been nationalized at a cost of $5.2 trillion to the US government's debt ledger. AIG's fundamentals look worse than Lehman's. And the FDIC is on a rapid path to implosion.

News events such as the above are the fundamental factors which drive the value of gold. It's supposed to go up when events such as these occur!

In fact, if investments didn't test and retest in this way, they would rapidly form into bubbles, and then, just as rapidly, pop. Investments just do this. It is a fact of the market.

Technically, gold has broken down from its almost 8-year bull market support levels.

The price of gold may now be in a bearish tailspin towards $600 which could persist for one to two years - or it may not be....

However, one fundamental fact must be considered. Gold is in a long-term bull market because global currencies are devaluing at a rapid rate.

Over a space of days, weeks, months, even several years, no investment price has to be rational (that is, driven by fundamentals).

Investment prices are driven by emotion-based and strategic human decision-making and by financial liquidity (the amount of cash investors have on hand), not by rationality.

In the present case, a liquidity squeeze has simply given investors less cash to deploy, even to purchase high quality investments, such as gold, precious metals, gold and precious metal mining stocks, etc. The demand for physical gold and silver
is at all-time highs. In fact, some physical gold and silver products are no longer even available at current prices, but global commodity prices are set in "paper" markets, where buying in almost all asset classes is declining. Real gold and silver are hard to find, but "paper" contracts in gold and silver are cheap, and perhaps getting cheaper!

Despite recurring departures from rational pricing, as is presently occurring, over the span of many years and decades, rationality has a tendency to assert and reassert itself. That is part of what the testing and retesting of prices is all about. Rational pricing exists between market extremes which are attributable to the vagaries of sentiment, liquidity flows and herd behaviour.

I find it helpful to anthropomorphize gold, which of course is the height of irrationality.

Gold is an inert physical substance without will and motive. It just is. Its value is in what it means to the humans who hold it as a form of savings.

However, it is simply too complex and counter-intuitive to interpret gold's behaviour in terms of the motives of all those who buy and sell it - "black box" computer programs, naive buyers and holders, and savvy traders included.

Adam Hamilton
has made a good case that commodities have recently been pulled down to irrational levels by their linkage to oil in the reformulated CRB index. His argument is coherent. Oil and its products now constitute 1/3 of the CRB, so when oil falls, all the indexed commodities come down with it.

But I'd rather think of it this way....

Gold has a personality, it is humble and unself-assuming, but supremely, flawlessly self-confident. Gold knows where it is going, but it doesn't care how it gets there. Further, gold doesn't like "easy-riders," those who are holding it for predictable (or "minimum") annual gains. Gold doesn't like those who hold it to place demands on it or who have very particular expectations of it.

Gold shrugs off all of that "relationship" stuff.

History tells us that gold is willing to take away 50% in one year, but to give back 100% in another. When it wants to....

And gold stocks can give and take away more!

In short, gold does what it wants to do on its way to standing still - as the only ultimately secure financial investment in the world!

When individuals, institutions and governments behave responsibly in matters of finance, gold doesn't have to do very much at all.

Gold is also willing to be forgotten while we are caught up in illusions of value in things that have no value (think of the US internet and credit bubbles as recent examples only).

Gold doesn't care what we do.

But it knows what it must do, and it does it effortlessly.

Gold stores value in all times and at all places.

It's that simple.

When we value gold at a price that is too low - as is now occurring - gold does not complain. In fact, it richly rewards those who buy it at such prices.

Gold is also willing, however, to disappoint us for extended periods of time. I have often made reference to the SPTGD (S&P TSX Global Gold Index), which has now provided no gains at all to its holders over the past 6-1/2 year period in which gold has tripled (and at one point, quadrupled) in market price.

Ha! Ha! Ha!

Gold doesn't care.

I do feel confident that when the gold price pulls back irrationally, particularly as powerfully as has recently occurred, this signals something entirely unrelated to failure.

The present reversion in the gold price is a signal of quiet, deep power. Gold is gathering its energies for its next surge. Given the sharpest pullback in the bull market to date, I think the next surge will also be the strongest in the bull market to date.

When will gold surge again?

Maybe today.

Maybe in two years.

Maybe... when it wants to.

Gold in fact stands still - it does literally nothing at all - while all the world dances around it.

All of the drama - the surges, the consolidations, the crashes, are phenomena that result from our human reactions to what gold is - which never changes.

We change.

Gold stands still.

This is relativity, more or less as Einstein understood it.

Gold will surge when we comprehend that the value of our currencies has receded. It is our own motion that gives perceived motion to gold.

I know that our human actions will cause gold to surge in market price - almost certainly in the form of a financial tsunami..

I just don't know when.

And I don't need to.

All I need to do is to hold gold, or to hold shares in mining and exploration companies that own the right to hold gold in the ground, or to extract it at their will.

Nothing more.

The golden tsunami will take care of itself.

Appendix: Mark J. Lundeen has published a 70-year analysis of bull and bear markets in all major market sectors. His finding - the present drawdown in gold and gold stocks is within 70-year norms, and they are well outperforming financial stocks, which of course are presently in "crash" mode. Click here for Mr. Lundeen's helpful article.

17 September 2008: Another landmark day in the markets. My present call is that today's $85.00 (11%) move in gold may have been the first ripple of the golden tsunami. The chart reveals that from its low to its high, gold actually moved an unprecedented $100.00 today in response to Ben Bernanke's "gassing up the helicopters" (a phrase I have borrowed from Bill Fleckenstein). Bear in mind that somewhere not too many years down the road, gold will trade up or down $85.00 in a day and we'll think nothing of it. It will be perhaps a one or two percent move. But in 2008, the $85.00 one-day appreciation sits on the ledger at 11%, and the trough to peak $100.00 shift at 13%. What a difference a day makes. Today offered a small taste of what the tsunami will look like, and again, today's action in gold represents only a ripple transmitted to shore from the mid-Pacific, where tectonic plates are shifting (as it were).

My gold tsunami posts are as follows:

There Is a Tsunami Coming in Gold

Gold Tsunami II: Anthropomorphizing Gold

Gold: Safe Haven in the Approaching Perfect Storm

Gold Tsunami III: James Kunstler's Use of the Analogy

Bond Prices: The Seismic Shift That Triggers the Gold Tsunami (IV)

Gold Tsunami V: The $23 Trillion Bailout... and Counting

Gold Tsunami VI: Looking for Patterns in Gold Price Advances

Gold Tsunami VII: This Is It

Gold Tsunami VIII: Gold Mining Stocks Now Participating

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