Sunday, October 25, 2009

A Shiny Bit of Perspective on the Metals That Gleam.

As the hate-mail has continued to pour into this writer's inbox, my position of selling out of the precious metal stocks that I purchased in late fall 2008 continues to be psychologically fortified.  After all, as I have said many times previously, I am as contrarian as I can be - the more hate mail I get (not that I'm a glutton for punishment or anything!), the more confident I am.

Loneliness, it seems, can be a wonderful thing at times.  In terms of finance it can be the best of things.

It is the state in which I find myself now - alone (or far enough between the few on my side that I might as well be) in my bearish calls on the precious metals.

I know that changing a gold bug's mind is about as likely as Mr. Obama having a personal free-market Renaissance, but I still feel it is my duty to try - the only wish I have at this point of the game is to save folks from making the mistake of trading something that is going to go UP in value for something that is going to go DOWN in valueThis is not the type of decision that makes the least bit of prudential sense, and yet, the number of those making it grows greater and greater daily.

But don't just take my word for it:

Gold Open Interest is far above the previous all-time high in March 2008.  the additional 50,000 open contracts is 500,000 ounces of gold, or  $525,000,000.00 of additional exposure to the gold market.  This is of course not including gold stocks, which have extremely low short ratios (the amount of shares short versus total shares available to trade).

A few examples, you say?  I though you'd never ask!

Barrick Gold - ABX - Despite having such crummy management of their hedge book (the $3.6 Billion in diluted new-share issues is most certainly not enough to cover the hedge book at this gold price), the short interest is at only 1.3%!  Meanwhile, 66,000 Call options contracts this month versus 31,000 Put Options should tell you the story - while the overall market is at 120% calls compared to puts, the most mismanaged major gold producer is at 213% calls to puts.  Sentiment is at major extremes toward all things shiny.

Anglogold - AU - Options for November expiry are at 10,000 Calls vs. 6,000 Puts - a 166% rate.  Over 35% higher than the market average.  Anglogold is trading at almost 5 times its book value, after having negative operating cashflow in the last quarter, and has only 1% short interest.  Again, extremely overdrawn sentiment driven entirely by hope for a massive continued run-up in gold's recent superman-esque run.

Current price inclinations on gold are the result of speculation only and are not fueled by real market fundamentals - credit levels have contracted in the US relative to the levels at the previous high in gold set in March 2008, debunking the Hyperinflationists philosophy.  The US dollar is not nearly at its low point of March 08, whereas gold is at a higher high almost inverse to the comparative difference in the USD from its previous Index price.  See here:

A major non-confirmation in what so many people see as the unflinching connection - that as the USD drops in value, gold goes up - shows us that the last legs of this rally have been driven by sentiment only and have no reflection of real fundamental aspects.

The "flee dollars" panic is so strong, and the "gold to $5,000" crowd getting so big, that any day now we could witness a drastic and sharp reversal that could wipe out these new record prices in gold in one or two trading days.

In the end, most glitter-loyal gold bugs, I recommend selling those mining stocks and closing out any open futures contracts on the shiny metals you might be exposed to.  Gold is about to get a heck of a lot cheaper.

For this, you should be celebrating.  Since your loyalty is undying no matter the economic environment, the opportunity to buy so much more precious metals with those worthless FRN's (Federal Reserve Notes, for those non goldbug-ese speaking readers) should be an occasion for joy and laughter.  Throw pride and unfounded claims to the wind for a moment and seize what may well become the last good buying opportunity for gold and silver as the final corrective wave of this depression takes them down to levels we can really call "cheap".

Our recommendations have not changed, meanwhile, for the broader markets - consider this lengthened (and fast waning) rally in the broad markets as a generous gift from Mr. Market.  You have the opportunity to cash out 50% richer than you were last March, and avoid the massive losses that those who are chasing "break even" are soon to incur.  Hold cash or the safest short-term equivalents and be ready to pounce on a highly depressed and pessimistic market in virtually every asset class under the sun. 

For the more aggressive investor and trader, now is the time to set up fantastic short opportunities in the broad market and the weakest/most overvalued companies. 

As always, be careful out there and watch yourself!


Full Disclosure:  While I own precious metals from years of accumulation, and generally favor silver much more than gold, I have not purchased any physical metals for almost 12 months, and do not plan to until a major correction in dollar terms (est. <$8/oz for silver) has occurred.  I own LEAPS on almost all of the major US banks, several commercial real estate companies, and Barrick Gold.  I also have transferred over 50% of my portfolio in cash form into short-term US treasury bills.

Remember, is the opinions and trading activity of the author only.  Any investment decisions you make are your sole responsibility.


  1. I'm sort of new to all of this so I may be missing something, but here's my question. According to the Mengarian explanation, which makes loads of sense to me, gold became money because it was relatively portable, durable, and useful for making things that people used. But it seems like all of the things that made gold an excellent trading commodity are irrelevant to people today. We don't carry around coins, everything is digital, gold is not used in many everyday items, etc. So, is there a modern equivalent of gold?

  2. Gold is its own monetary equivalent. There is roughly 1 ounce of gold above ground and purified for every man, woman, and child on earth. About $6.5 Trillion worth. This is easily enough money to facilitate global trade, etc. Gold physically doesn't need to be used as money as it is even easier to carry around a "bearer note" that entitles the bearer to a certain amount of gold.

    I.e. before 1933 all US bills said "this note is redeemable in gold". You could take $100 to the bank and trade it in for physical gold. Most people didn't, however, as the bills were even easier to handle - it was the value behind the paper that made it relevant. Today there is no such value - the only thing that gives fiat currency its value is that the government created a legal system in which all legal contracts must be written in legal tender (dollars). If a contract is determined by anything other than dollars, it cannot be enforced in court. I.e. if someone rips you off you have no means of getting your end of the deal.

    So there is currently a monopoly on the use of paper money created by the government. The only feasible explanation for this is that the government is the first beneficiary of fiat currency in that whatever budget (i.e. deficit) they run, there is always a buyer of last resort (the private banking system), willing to print the dollars to fund their ambitions. Meanwhile most people accept inflation as normal, when in fact it is a phenomena - a deliberate action must be taken in order to create inflation (i.e. printing money or doubling the monetary base). Whereas natural and slow deflation is the normal course of a society using actual asset-backed money as opposed to debt-based fiat currency.

    This translates into slow and surely falling prices over time as the economy actually grows faster than the amount of money. Thus, using gold or silver or oil-backed money or whichever, your "cash" savings actually increase in value over time! For example, the price of a loaf of bread in the US decreased by 10% from the late 1700's to the late 1800's. Imagine being able to stuff your cash under your mattress and know it would buy MORE when you retired. This is the normal course.

    Gold as money is vitally important to a growing economy. With fiat currency, eventually the debt levels of the whole economy reach an unsustainable level and credit default occurs. The economy cannot handle servicing the debt. For example, if you look at debt levels versus GDP growth in the last decade, it took $6 of debt to create $1 of new GDP.

    This is a long-term cycle of fractional reserve banking that plays out and usually crashes about once every 80-100 years, where basically the entire economy goes into default. Thus money is evaporated because the debts are not repaid, and thus the money supply contracts violently. This is unnatural deflation and only results from fractional reserve banking. We are in the middle of this very rare era right now. This is why gold (relative to dollars) is going to suffer a fairly serious price contraction over the next 6-12 months. There will be less dollars with which to buy it.

    This ran on a bit longer than I'd hoped lol, however I hope this information helped. If you need any more email me back and I'll find you a couple of good primer articles from the Austrian school.

    Thanks for the question! Nice to not get a hate letter :)


  3. Also as a quick follow up I am not necessarily an advocate of gold only as a monetary device, because if it is money "by law" then it is still a government-induced monopoly - I am a fan of whatever the uninhibited free market chooses to use as money. If it's gold, silver, potatoes, walnuts, tires, water, or whatever!

    Whichever the market chooses is and always will be the most efficient and value-holding means of monetary exchange. If interested in monetary alternatives you should look up some of F. A. Hayek's essays on money itself.