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Ay, caramba! Not
to put too fine a point on it, gold bugs got hit in the face with a frying
pan this week. The yellow metal dropped like a hot rock on Monday, hitting
its lowest levels of the year.
So what in the
world happened? And is all hope lost for gold?
The short answers
to those questions are as follows.
- South Ossetia happened.
- No, all hope
is not lost. In fact, gold will be a screaming buy again at some point
down the road.
Let me explain...
Russia, Georgia
and the Dog That Didn’t Bark
To start,
you’ve probably read about the shooting war that flared up between
Russia and Georgia (the country, not the state) over the past week or so.
One minute,
Russian and Georgian leaders were focused on the 2008 Olympic Games in
Beijing. The next minute, Putin was flying home as fighter jets scrambled and
tanks rolled in to South Ossetia.
It’s a
fascinating little conflict. U.S. politicians are putting all the blame on
Russia, but things are a bit more complicated than that.
I’d love to
dive in to the geopolitical implications of what just happened -- and they
could be big in the long run -- but that would be a distraction from our gold
discussion. So we’ll leave the political analysis alone for now.
To understand why
gold fell through the floor, you first have to understand some basic trading
psychology. One of the most powerful trading adages around -- and one
we’ve mentioned in these pages repeatedly -- is that “it’s
not the news, it’s the reaction to the news.”
As a trader, you
look at how a market reacts to news, good or bad, to determine how
strong or weak the trend really is. If a strong market reacts poorly to good
news, that’s a sign that maybe it wasn’t so strong after all...
or that maybe the strong trend is now weakening.
Conversely, if a
bearish and beaten-down market shrugs off a round of further bad news,
that’s a sign that perhaps the bearishness has run its course.
Getting back to
the Russia-Georgia shooting conflict. The key “tell” for traders
here is that gold didn’t jump up when conflict broke out. Under more
normal conditions, you would expect gold to see a huge pop on news of
military conflict in an unstable region.
So when that didn’t
happen, it was sort of like Sherlock Holmes’ “dog that
didn’t bark.” The fact that gold reacted poorly, when it should
have acted strongly, caused traders to rush for the exits. And that stampede
in turn caused the price of gold to fall through the floor.
Commodity
Correction and Euroland Recession Fears
As you are likely
aware, gold’s weakness comes against the backdrop of a massive
commodity correction.
The Reuters /
Jefferies CRB Index ($CRB) is down over 20% from its 2008 highs (although it
is still substantially up on the year). The U.S. dollar has also exploded
higher this month, putting in one of its strongest trading performances in
years.
This is
happening, in part, because of a big sentiment shift between the U.S. and
Europe.
For a while it looked
America’s economy was sick while Europe’s economy was strong. Now
the buzz is that perhaps things are the other way around... maybe America
will slip past the credit crunch mess relatively unscathed, while Europe
takes the harder hit.
As a result of these
whispers, along with fears of global slowdown, you have the dollar going up
while commodities go down. (The euro has also gone into freefall, which WaveStrength
Options Weekly readers should be particularly happy about... Adam
recently sent me a note to gloat over the absolute killing he is making on
Euro FX puts.)
The Worm Will
Turn Yet Again
So that’s
the long and short of it. Against a big dollar rebound and a general
commodity correction, traders were already feeling anxious about their hefty
gold and oil positions.
In other words,
these guys were already as nervous as a long-tailed cat in a room full of
rocking chairs when the Russia-Georgia shooting war broke out... and so when
gold failed to respond the way it should to the prospect of military
conflict, they ran like hell for the door.
But here’s
the thing: This commodity correction is just that -- a correction.
We’re in maybe the third or fourth inning of a nine-inning game. The
idea that global slowdown will put an end to the commodities run is just
silly.
A quick
anecdote... I hardly ever read USA Today, except when I’m
traveling. When they put it in front of my hotel door in the morning,
I’ll occasionally flip through it over breakfast, just to see what
mass-market America is reading.
In San Francisco
this past week for the Global Opportunities Summit, I saw a USA Today
headline that caught my eye. I forget the wording, but the gist was
“Commodity Bull Market May Be Over.”
Now let’s
be serious here, I ask you: If The Economist, the Wall Street
Journal and the Financial Times can’t get the major market
calls right -- upstanding publications that they are -- what are the odds
that the all-time top for one of the biggest bull runs this century has seen
is going to be called by freakin’ USA Today?
Pardon my French,
but there’s evidence out the ying-yang as to why the commodities bull
is far from over. We’ll get into that more in future Taipan Dailies...
but I’m closing in on 1,000 words here so it’s probably time to
put away the soapbox on this subject. (I think after I hit the
‘Send’ button, maybe I’ll go do some tai chi just to calm
myself down.)
Oh, and as to why
gold will come roaring back?
In a nutshell, inflation
isn’t dead. Not by a long shot. That’s another thing Wall
Street doesn’t really understand... why the prospect for a massive
inflationary tidal wave actually requires slowdown fears to kick in
first.
I’ll
explain what I’m talking about there when I write to you again on
Friday. That will help you see why a time is coming when you’ll want to
buy gold with both hands. (I know I will be.)
Warm Regards,
Justice
Litle
Taipan Publishing Group
Justice
Litle is the Editorial Director of Taipan Publishing Group
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