Is More Pain Ahead for Gold Investors?
October 14, 2013
Chad Karnes, Chief Market Strategist
Since the precious metals bubble began almost 10 years ago, the prices of gold and silver have been driven more by fear, greed, and other emotions than by fundamentals or allegedly rational reasons.
Gold pays no dividend and provides no cash flows, actually costs money to own (storage fees and insurance premiums), and is used in relatively very little industry compared to other asset classes such as land, housing, equities, bonds, or even timber. You simply can’t value precious metals the same way you do other investments.
If most gold (NYSEARCA:XME) isn’t owned for sound fundamental reasons, it seems investors must stop trying to value it in fundamental ways and focus on what really matters when it comes to the precious metals markets.
What Really Matters with Precious Metals
There are countless examples of “experts” getting the gold trade wrong as we have highlighted numerous times throughout the years; one such example was our article, “Is the worst really over for gold and silver?”
All the gold bugs (NYSEARCA:NUGT) who have been touting gold for years based on “fundamental” reasons such as the Fed’s non-stop printing press are now getting crushed. They rode the precious metals bubble falling victim to one of the oldest axioms on Wall Street, “everyone is a genius in a bull market”. Discussed in our article published on May 6, if the real reason to own gold is the printing press, then shouldn’t the U.S. dollar also be getting hammered?
WATCH: How Gold Experts are Misleading the Public
These experts confused their “correctness” through 2011 with simple correlation of a precious metals market rising because of an entirely different reason, euphoria (just as has always driven the gold market).
In 1999, when gold (COMEX:GCZ13.CMX) was trading at 30 year lows, no one wanted to touch the precious metal. Contrast that to 2011 when “sell your gold” commercials were on every television channel. Those commercials meanwhile can still be found.
Even central banks around the world were selling gold at its 30 year price low and buying at its all time high.
As an example of just how clueless central banks (and others) have been when it comes to gold, Ben Bernanke himself said to the Senate Banking Committee in July, “Nobody really understands gold prices and I don’t pretend to really understand them either”. Yet central banks continue to buy and sell gold.
In July 1999 when Gold was hitting its 30 year price low of $250/ounce, the bank of England sold a massive amount of gold, solidifying the reserve banks in history as horrible market timers.
In 2012, when gold prices (NYSEARCA:GLD) averaged $1650/ounce, central bankers around the world bought 535 tons, the most purchases since 1964. With gold now below $1400, again the world’s bankers are helping mark the top in gold as they lose over $500 billion dollars and counting since the great gold peak of 2011.
Euphoria and Emotion
As I outlined in our April ETF Profit Strategy Newsletter, released March 22, 2013 when gold was trading over $1550/ounce, it was no surprise to us that gold peaked in price in 2011 as euphoria went sky high.
“The peak of pop culture’s obsession with gold occurred right around the time that gold prices peaked at $1900 in late ’11. We don’t see it as a coincidence that Pawn Stars was the 2nd highest rated television show in ’11 just as another popular gold focused television show, Gold Rush: Alaska was in its inaugural season.”
Countless treasure hunting television shows remain in popularity still today.
Will History Rhyme?
The precious metals (NYSEARCA:IAU) have always been driven by euphoria or lack thereof. In 1980, the previous peak in gold prices sent shares up to $850, also then a record. However, within two years, gold prices were back below $300, falling over 50% from its peak.
Still today an investor that bought gold in the late 70s would have lost money after inflation. According to the Fed Bank of Minneapolis, gold around $1400 today is worth only $464 in 1980 dollars, a far cry from the 1980 peak of $850, proving that even with the precious metals, there are good times to buy and also very bad times to buy.
Buying “at any price” is likely a losing strategy, just as it is with all assets.
If euphoria and emotion are what drive the prices of the precious metals, then we should use them to help identify when gold and silver (NYSEARCA:USLV) are good or bad purchases. We shouldn’t rely on fundamentals or other justifications that simply don’t correlate much with price.
Our April Newsletter helped show why gold prices topped out in 2011 and why the precious metals were likely entering a long term bear market.
Profiting From Gold and a Long Term Projection
We have been fortunate to capture many of the great gold turning points (NYSEARCA:GDX) over the past year as my article, “Is the Great Gold Crash Over?” outlines a few of them. Much of this was because we ignored the mainstream media and listened to our unbiased charts and sentiment measurements.
That analysis helped us capture profitable trades, both long and short on 7/13, 9/1, 9/15, and 9/18.
Last week, we suggested buying the Direxion Daily Gold Miners Bear 3x (NYSEARCA:DUST) to take advantage of another opportune technical setup. That trade was already up over 10% in less than a week. Our tandem trade of buying Dec GDX (NYSEARCA:GDX) put options was comparably up 30%.
Gold’s long, medium, and short term trend are decidedly down, and using these charts, history, and sentiment measures help us target $1,000 for the price of gold.
The chart below of gold’s ETF proxy, (NYSEARCA:GLD), helps put this target in perspective as gold is behaving very orderly from a technical perspective.
Gold's July rally to backtest its trend (shown by the green arrow) is a key technical setup that we combined with our short term outlooks to help provide our September short recommendations when GLD was trading back above $135. Already, traders have made over 10% from those short recommendations, over 30% if they used the levered ETFs suggested, and more than doubling their money if they used levered options.
In reality, a gold decline (NYSEARCA:GLL) of 50%, targeting $1000, may actually be conservative as the 1980s price action taught us. Back then, precious metals (NYSEARCA:DGLD) gave back over 50% of their gains in just two years! But ultimately, they gave back over 70% by 1985.
Thus far, the gold decline (NYSEARCA:PHYS) has lasted two years, and prices have been chopped around 40%. Market history, the charts, and sentiment all suggest this trend should continue until gold bugs really start to throw in the towel.
At that point it will likely be a good time to buy the metals again. However, that time could be years away, when the world’s central banks and gold bugs finally completely throw in the towel.
The ETF Profit Strategy Newsletter uses technical, fundamental, and sentiment analysis to keep investors on the correct side of the markets. We offer actionable ETF trades through our monthly Newsletter, Weekly Picks, and twice weekly Technical Forecast. Since the beginning of the year through the end of Q3, 74% of our Weekly Picks have turned a profit and 525% was our biggest gainer.
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