Historic price actions for gold

It is time that I put up a new post on precious metals. 

It has some historic moves. As I write, it is hovering around $1,350 an ounce. That's a 28% drop from its all-time high of $1,895 on September 5. It's the biggest two-day drop for gold in 30 years! This was also the biggest back to back drop sinc 1983.

Gold is still at its most oversold level since 1999.  Let me give you a perspective in a different angle. The amount of paper gold sold is equivalent to 100 years of production allegedly sold in one day. Comex traded an amount greater than the total above ground silver stores on the entire planet. 

Dr Craig Roberts made the following comments:

"Consider the 500 tons of paper gold sold on Friday. Begin with the question, how many ounces is 500 tons? There are 2,000 pounds to one ton. 500 tons equal 1,000,000 pounds. There are 16 ounces to one pound, which comes to 16 million ounces of short sales on Friday.

Who has 16 million ounces of gold? At the beginning gold price that day of about $1,550, that comes to $24,800,000,000. Who has that kind of money?"

What is happening?

Gold has had a dozen reasons to rally over the past six months. 

• the European monetary crisis, the Italian elections, the Spanish elections, 
• the Cyprus bank account seizures
• sequestration 
• the fiscal cliff, 
• Ben Bernanke’s QE3
• the Japanese ultra QE
• rising capital gains taxes
• the reelection of president Obama.
• negative real interest rates in the U.S. ...
• $7 trillion more in federal deficits ...
• multiplied our monetary base at the fastest rate in the history of this country and we're still printing approximately $85 billion a month ...
• Central Banks around the world are now engaged in currency wars to see who can devalue their money even faster ..

But it is not acting with the fundamentals. So short term, I stay bearish.

I am over hedging many of my positions and actually taking advantage of the downward momentum to make some money. But one has to be very vigilant. A rebound will be fast and furious. Thus, I will be ready to take profit very quickly.  It is a difficult play. For small positions, you might keep it and average up when the trend is back.  You can easily be whipped sawed if you short.

It is actually hard to conceive how one can be bearish in precious metals in this environment. 

Seth Klarman, the legendary value investor and head of the Baupost hedge fund described the situation like this in his annual letter:

"The short-term palliatives we are currently pursuing go against everything a long-term-oriented society should aspire to achieve. Today's policies encourage spending over savings, reward the profligate over the prudent, and support the failing at the expense of the successful. The antidote now being dispensed puts us squarely in uncharted territory in which the risks are outside the range of historical experience..."

We believe the world's economy is now entering a kind of blind alley. By willfully abdicating the responsibilities of the markets – by monetizing our debts, by deliberately inflating our currencies, by bailing out failed companies, and by promising to deliver more benefits than can be afforded – the major economies of the West (including America's) have chosen the path of socialism."

Besides, there are reports of  extraordinary physical deliveries, not just through London but also every other major global center including Shanghai. I cannot verify this but I believe it is true. There is record demand for metal from the US Mint. The official Chinese confirmed 90 metric tonnes of metal import in February  alone.  

Two weeks ago, ABN AMRO  failed to deliver the physical gold of customers that were in their vault. This is technically a default. 

These are all anecdotal evidence that there are bullish forces for gold despite the extreme bearishness of price actions right now.

There are possible reasons for smash of gold prices too. 

Many gold bugs scream conspiracy theories and manipulation. I reserve my judgment on this. 

It is possible that the world is dumping hard assets of every description and pouring the money into paper ones. Commodities you can drop on your foot are getting dumped, and generous premiums are being paid for anything that can be created with a printing press. It is hard to believe but it is the way price are moving now. If this is true, it is short sighted and the trend will not last for long. 

This is also why both bonds and stocks going up at the same time, a rare event in capital markets. In effect, everything is now a bond, both the wide array of fixed income securities that are getting chased, along with dividend yielding stocks. This is why a wide swath of technology stocks, like Apple (AAPL), are not participating in the game. 

Some funds will be in trouble. The recent yen volatility has got some speculative funds into trouble. For that matter, when markets moves violently, there will be funds in trouble. The easiest thing to do to cover margin calls and redemption from customers is to sell including your long term gold holdings. John Paulson's fund is one of them. With the current gold price movements, I believe more funds will be in trouble. Margin clerks will be quite busy right now.

It is also that central bank printing is losing its impact on the markets. There are too much debt floating around the globe and there is not way central bank money printing can offset it. With the austerity in Europe and United States, there are overpowering the inflating impact of money supply.

Interestingly on the contrary,  Japan’s new aggressive policy to devalue its currency is also not bullish for gold. Japanese investors are plowing their money instead into their own stock market, and my sources tell me loads of Japanese capital is also fleeing to our stock market. People are looking for safety in cash and stocks.

All that matters is whether the sellers are in control or the buyers. All that matters is whether the market is in a bull market or a bear market and that is ALL YOU NEED TO KNOW. Trying to figure out why gold is dropping right is the wrong thing to do now. It is dropping because it has been in a bear market for almost two years now and at the end of bear markets you can get crashes and extremes in bearish sentiment as every person who is a potential seller finally sells in a giant capitulation.

When is the bottom?

Now, how do we know when it the bottom.

I will use silver for the analysis as it is highly correlated with gold. 

From a historical perspective, there were 5 major crashes in the last 10 years. I should say the bottom is quite close.

 

You can also examine the COT just before the crash, silver short is the highest in 2 decades. 

Lastly, lets look at Gold miners' bullish sentiments.  I wonder how low can it go. It is usually a good contrarian indicator.

As for gold stocks. the valuation really cheap. They are so cheap that no one wants them anymore.NEM is paying a 5% dividend. The gold stock ETF GDXJ is paying a 6.13% dividend.

When will I buy?

So, it is my belief we are in a capitulation phase. The volume transacted also pointing to this direction. We are near the bottom.

The mistake is usually made when one tries to catch the bottom. I will let the price actions show me the bottom itself. 

My guess, is that there will be a some strong rebound within the next few days. After that, there will be selling. The strength of the selling usually establish the bottom if it clearly stops at a higher low. Normally, it results in a cup and handle, head and shoulder or saucer formation. It is better to wait for the pattern to demonstrate itself. It needs a lot of patience. You can make good money trying to catch the bottom but you can lose big too.

Also, there could be be quick reversal with "a morning star" candlestick formation and reverses straight up. This is less slightly scenario unless it is followed by some clear fundamental events. A lot of technical damage has been done.

So when only when some bottoming action manifests itself,  you can start bottom fishing with naked or bull puts. Be very careful. If you are wrong, exercise your secondary exits which I had outlined in various posts in this blog. You may need to test the bottom a couple of times before getting it. If you are careful you will not be burnt and may even make some money as the price continues to move down. With options, the volatility allows you to safely test the bottom.

Once you are right and trend is clear, go with stocks or covered calls. If there is momentum, I will go with call calendar and calls.

The actions over the last few days show that some historical change is happening.  Eventually we will see the end of the Great Keynesian Experiment. Gold, commodities and hard assets will resume its appropriate positions in your investment assets. 

When it happens, these are the extremes in the market that helps in extraordinary gains.