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This
essay is based on the Premium Update posted November 27th, 2009
In a
world of paper currencies and paper promises, I can think of many reasons
right off the top of my head why the price of gold will continue to go up in
the long term, however since this essay's length is limited, I'll just
mention 5 of them. In short, while it may feel like a bubble to some, I
believe we are just warming up.
Last
week I mentioned a few of such reasons, but I would like to expand this topic
this week. Below I have featured ten of the many points that currently point
to higher value of the gold price in the long run.
1. The
smart money is already piled into gold. Some of the world’s savviest
money managers have taken large positions in gold. I mentioned John Paulson,
David Einhorn, Paul Tudor Jones and Jim Rogers I forgot to mention George
Soros, who increased his holding in gold in the third quarter with gold
mining stocks and with the SPDR Gold Trust ETF. This week the Wall Street
Journal reported that John Paulson, who I did mention last week, is launching
a new gold fund, which will include $250 million of his own personal
investment.
Other
well-known fund managers publicly piling into gold include Bill Gross, Kyle
Bass (Hayman Capital), Paolo Pellegrini (PSQR), John Burbank (Passport
Capital), Evy Hambro (Blackrock), Donald Coxe (Coxe Advisors), and David Tice
(Prudent Bear Fund). I would expect other major mutual funds, hedge funds and
pension funds to follow their lead.
2. Central banks are net buyers of gold for the first
time in 22 years. This is a major secular change. According to a report by
precious-metals research firm GFMS, for the first time since 1987, central
banks around the world bought more gold in the second quarter than they sold.
India recently bought 200
tons of gold from the IMF and China
is expected to purchase the other 200 tons offered for sale.
3. In
June there was an item in Bloomberg about Northwestern Mutual Life Insurance
Co., the third-largest U.S.
life insurer, having bought gold for the first time the company’s
152-year history. According to the report, the insurance company has
accumulated about $400 million in gold. I would expect that other insurance
companies might follow suit.
4.
China
holds $2 Trillion in Foreign Currency reserves and only 2% in gold, vs. a 10%
worldwide average. The Chinese are seeing the value of their foreign currency
reserves turning to dust every day. If China
makes the logical move to increase its gold reserves and reduce its fiat
currency exposure to even just the worldwide average, gold prices could move
substantially higher.
5. Gold
is scarce. The gold industry has not replaced gold reserves mined in over a
decade meaning near term shortages. We might get to a situation where there
is simply not enough physical gold available to cover the massive quantities
of gold that has been pledged. This situation could push the price of
gold to the stratosphere. Hong Kong has recently pulled all its gold
holdings and deposits from London
and brought them home. While investors chase
gold to get into something more stable than the dollar, producers aren't
keeping up. Gold production was down 3% last year, and it was flat in the
most recent quarter. Although mining companies are spending more on
new production, especially in China and Russia, that is not enough to offset
dwindling output from mature mines. Central banks hold a lot of gold. But
they are not interested to sell and in any case, they are bound by an
agreement that imposes limits on sales.
However,
the road to the top will not be a straight line, and since that is the case
it makes sense to take advantage of the inevitable corrections. Let's examine
the chart (charts courtesy of http://stockcharts.com) of
gold to check if we are close to another buying or selling opportunity. In
this essay, I will focus on the precious metals stocks.
The
precious metals stocks are very close to their key resistance levels created
by the March 2008 and July 2008 highs. The HUI Index has just moved above the
latter resistance, so it is likely to correct soon. The 500 - 525 area is
still a possible target for this rally, but the risk of a sell-off has
increased significantly after the very recent developments on this market.
Additional
confirmation comes from the main stock indices.
Much
has been written about how overvalued the general stock market is, and how
likely it is that it will plunge immediately, after which stocks moved lower
for a few days, but in the end rallied again and again.
However,
the strength of the bearish signals has increased even further in the past
few days. The divergence created by the NIKKEI Index moving visibly lower has
become even bigger, but the most important bearish signal comes from the
analysis of volume. The volume has been declining in the past several weeks
along with rising stock prices, and the scale of this phenomenon has been
remarkable.
Could
this mean that the main stocks indices are likely to follow and move lower in
the not-too-distant future? Historical performance of the financial sector
relative to other stocks confirms this, so we - the precious metals investors
and speculators should at least take this possibility into consideration,
especially that for now, PMs remain positively correlated with the general
stock market.
The
values of the correlation coefficient are low in the long- (750 trading days)
and very-long-term (1500 trading days) columns, but the analogous values in
the short- (30 trading days) and medium-term (90 trading days) are positive.
In other words, a plunge in the general stock market may have a negative
impact on the precious metals market in the short term, but it will not be
the key driver of the PM prices in the long run.
Summing
up, the
precious metals stocks have moved very high very rapidly and this fact by
itself suggests that a correction is to be expected. Since the HUI Index is
just reaching its key resistance levels, a breather may materialize very
soon. Additional confirmation (the general stock market appears to be highly
correlated with the PM stocks) comes from the general stock market, which may
- finally - move lower. Additional details are available in the full version
of this essay, including the detailed short-term GDX chart along with
projection of the next cyclical turning point.
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Thank you for
reading and have a great and profitable week!
Przemyslaw Radomski
Editor,
www.sunshineprofits.com
Also
by Przemyslaw Radomski
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