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Gold's Bluff - Is A 30 Percent Drop Next?

Apr 01, 2009
Simon Maierhofer

You would expect gold prices to soar amidst the biggest market meltdown in decades. Yet, gold prices remain stagnant. Even the government's plan to devalue the dollar and China's suggestion of a dollar replacement didn't propel gold. If gold can't rise now, when will it ever?

You don’t have to be a “gold bug” to see how gold stands to prosper from the current economic environment. However, projections of gold skyrocketing to $1,500 and beyond have so far been unfulfilled. Fact is that gold has gained no more than 2% over the past year and in essence has been range bound.

Gold reached an all-time high of $1,014/oz in February 2008. After correcting some 25%, gold took a stab at taking out the ’08 highs in February 2009. Prices reached $1,007/oz but failed to set new highs. This non-confirmation of an up-trend is usually viewed as a bearish sign.

While investors have lost their pants with stocks, gold has at least been a safer place to park money.

As a side point concerning equities, the ETF Profit Strategy Newsletter said the following about stocks nearly three months ago: ”The best target for a low is 6,700 for the Dow (AMEX: DIA) and 700 for the S&P 500 (AMEX: SPY). Extreme pessimistic sentiment may drive the indexes even towards Dow 6,000 and S&P 600. Once the new lows are reached, the markets should stage the biggest rally seen since October 2007.”

Unless you implemented any of the ETF profit strategies given with the above update, gold was the safest place to hide. Nevertheless, if gold doesn’t skyrocket in an environment where the Dow drops 2,500 points, trust in the financial sector (NYSEArca: XLF) has completely vanished and the government’s is actively devaluing the U.S. dollar, when will it ever?

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As published in the March 5th edition of the Investor’s Business Daily, I’ve been bearish on gold and silver for several weeks (go here for the related IBD article on gold ETFs). The $900/oz level has proved to be a strong area of resistance against lower gold prices. On March 18th, gold fell below $900/oz and was down over 5% half way into the trading day. Within minutes, the tide turned. The Fed’s announcement to buy $1.2 trillion of government and government agency bonds (such as Fannie Mae and Freddie Mac) propelled prices immediately.

Gold ETFs such as the SPDR Gold Trust (NYSEArca: GLD) and iShares COMEX Gold Trust (NYSEArca: IAU) gained nearly 9% before selling pressure resumed.

Silver ETFs such as the iShares Silver Trust (NYSEArca: SLV) and PowerShares DB Silver Fund (NYSEArca: DBS) soared 17% within three days. The iPath DJ AIG Platinum ETN (NYSEArca: PGM) was up 14% by March 26th.

Similar behavior was observed in government Treasuries of various maturities. The iShares Barclays 3-7 Year Treasury ETF (NYSEArca: IEI) rose 1.79% the same day. The iShares Barclays 10-20 Year Treasury Bond ETF (NYSEArca: TLH) spiked 5.57% for the day while the iShares Barclays 20+ Year Treasury ETF (NYSEArca: TLT) soared 7.11%. Those are huge movements for government bonds.

It’s hard to imagine a single news item with a more profound bullish effect on gold prices than the government’s plan to print an additional $1.2 trillion of U.S. dollars therefore devaluing the exiting dollars in circulation. Even China’s suggestion to replace the dollar with a “super-sovereign reserve currency” was not able to lift gold prices past the ’08 high.

For over a year investors have been pouring money into gold ETFs, $31.50 billion to be exact. This flight for safety has made the SPDR Gold Trust (NYSEArca: GLD) the second largest ETF in the world. Yet, all the demand for gold has not translated into higher prices.

As mentioned in the January 15th, ETF Profit Strategy Newsletter, “Once the new lows are reached (between Dow 6,000 and 6,700), the markets should stage the biggest rally seen since October 2007.”
The markets have rallied over 20% since the Dow 6,446 low on March 9th.

As this foretold rally develops, investors will start to believe that the worst is behind and once again fall in love with equities again. The perception that bigger gains are to be found in stocks will rob gold of its luster. Who wants safety if you can make more money with stocks?

As the financial system deteriorates, the significance of gold as part of the monetary system will eventually increase. A retest of the $700/oz level however, is likely before a sizeable move to the upside. A break of the 2008 highs would reduce the short-term bearish case for gold and silver.

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ETFs designed to benefit from falling gold prices include the UltraShort Gold ProShares (NYSEArca: GLL), PowerShares DB Gold Short ETF (NYSEArca: DGZ) and PowerShares DB Gold Double Short ETN (NYSEArca: DZZ). The only ETF to rise when silver prices fall is the UltraShort Silver ProShares (NYSEArca: ZSL).

Ironically, gold is more than just a hedge against market turmoil. Gold is actually one of the most accurate indicators of the stock market's long-term direction. The Dow Jones measured in gold is a forward looking indicator. As such, it has mapped out the long-term direction for equities already. You could say that the stock market’s fate has been sealed.

The March issue of the ETF Profit Strategy Newsletter contains a detailed analysis of the Dow measured in gold along with a study of three other long-term indicators: dividend yields, P/E ratios and investor sentiment. The consent of all four indicators is amazingly harmonious and shows with little doubt where the market is headed. Knowledge is the most important asset when it comes to protecting and growing your wealth, however as Sudie Back put it, “Be curious always! For knowledge will not acquire you; you must acquire it.”

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