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« Agnico-Eagle Mines Limited: Opportunity or Trap? | Main | Gold and Gold Stocks: Hammered by global De-leveraging? »
Friday
Oct242008

Gold: Where Do We Go From Here?

Having received many emails and comments asking a variety of questions regarding the markets recently, we are going to do our best to briefly outline where we should go from here.

Firstly, what is happening?

An immense amount of our financial system is built on credit, credit that is now rapidly deteriorating. This is causing a sell off in just about everything, regardless of the fundamentals or technicals of the assets in question. This has been seen to a great extent in gold stocks, with many being sold down to the same prices they were when gold was $500/ounce. Think of the markets as people standing on a carpet rug, and the rug has suddenly been ripped from underneath them. Everyone falls down.

This “mass exit” from just about everything has caused a rally in the USD, since most of these assets are dollar denominated and therefore there is a strong demand for dollars from investors wanting to get out of positions.

The greenback spike has also been caused by non-US central banks cutting interest rates. The feeling is that many central banks will continue to cut rates, but the US is limited at how much more it can cut its interest rate, since at present it stands at only 1.5%. The same goes for Japan, which is why both the US dollar and yen are experiencing sharp rallies.

USD dollar long term chart
(click and click again to enlarge)

The rally in the greenback and the withdrawal of credit from the system has caused commodities in general to also fall, reducing inflationary pressures and therefore the need to own gold as an inflation hedge. This has damaged the saven haven case for investing in gold and gold stocks.

Gold - Where We Go From Here
(click and click again to enlarge)

There is also the deflation/inflation debate surrounding what kind of a recession we are going to be in for. We are of no doubt that the vast amounts of money being pumped into the system will cause serious inflation worries, but the question is when? If everyone is prepared to just sit on cash for a year, the inflationary effects of the massive cash injections by the US and others will not be felt for a year. Also investors will probably keep moving into US dollars and yen while other currencies can cut interest rates and devalue their currencies more than the US and Japan. Perhaps when every major central bank in the world has rates of between 0%-2%, investors will then move to the currencies of the country's that are in the best economic shape, and that is definitely not the USA.

Our stock positions have been hammered, we feel the pain too since we hold all positions that we recommend.

Our option positions have similarly been slaughtered, but we have had a number of 100% option wins this year to counter balance the losses, so we are about even on our options trading operations this year.

Currently we are holding our positions in our gold stocks, gold options and cash. There are a few events that need to pass before we make a decision to either reduce our holdings or increase them. First up is the US election and the weeks that follow it, these will no doubt be critical to the markets. There is also the issue of the December gold contracts on COMEX, and whether the sellers will be able to deliver the gold they have promised.

Once these events have passed, we will make decision on whether we are going to hold, reduce our position or back up the truck.

Until then, we will sit tight.

Footnote: We are looking at an options strategy that could provide some income during these volatile times, essentially betting on volatility. We will publish our ideas for discussion shortly.

To stay updated on our market commentary regarding gold, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address.

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter. Just click here.

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Reader Comments (16)

Your sign up link for newsletters doesn't work, at least in Firefox. Just puts you in an endless loop of security entries.

October 25, 2008 | Unregistered CommenterChris Kern

What happens if and when there is a default on gold futures contracts? I 've heard physical gold prices will jump.
What about ETFs like GLD?
There is numerous mentions of a possible default, but no one is commenting on the ramifications.

October 25, 2008 | Unregistered CommenterJ. Wendell

I would like to add some comments about the greenback rally lately.

You see a flight to Green due to the following main reasons;
- Fear of (deep) recession in Europe, which causes lower interest rates (although substantially higher yet than USA) depending on its severity(which has to be shown yet).
- Debt deleveraging; US overseas capital flows back to mainland US, due to margin calls and much needed liquidity.
- Asian/Middle East investors (SWF's) buying US Treasury bonds to put their excess money at work when everything else freefalls.

With these denomitating events, the inflationary pressure of excess dollars in the system is off for the moment. This is caused by deleveraging. When central banks lend money out to Wallstreet banks, WS banks then leverage the amount to about 25-35 to 1 on the capital markets. The well-known fractional banking. The opposite happens today.
This deleveraging cycle takes at least 6 months to years from now, to set off every loss in the system. It cannot be written off instantly, because (almost) every bank would be bankrupt immediately. Deleveraging takes time...and write-offs. Were talking trillions here.

That events is called a contracting money supply. where money flows out of the monetary system. And it happens worldwide, diminishing growth and inflation. Actually the opposite of paper money growth is deflation. That is what starting to happen today in the US according to my senses.
Europe, hasn't seen deflation yet, but lower growth figures of inflation, thus called recessionary.

Back to the Greenbacked dollar.
The scary part of the US Fed's overnight rate is that it comes closer to zero percent interest. The lower this rates get (though there are other measures available) the less tool the FED has for keeping the money flow INTO the system with cheaper loans to banks and corporations. Europe has more slack, since it has a more diverse economy and stricter regulations for fractional banking (example: In the Netherlands, banks are allowed to leverage only to about 10 to 1 basis). And things are getting worse when days pass by.

The Greenback will get stronger if deflation occurs, if not already happening. Then the currency goes way past the 0.9 barrier the technical indicators show above. If that happens more, I am going to buy dollars, to exchange them back to Euro's some time later. That should be easy money.
But for dollar denominating countries is disaster. Except for one group of people; the Rich.
They have surplus money (no debt) and in deflationary circumstances, that nominal money value grows with the deflation rate at that particular moment in time. Not really beneficiary for the rest of American, who are debt based and in balance, don't have a dime left in surplus.

Hope this clarifies the greenback possible flights for the future.

October 25, 2008 | Unregistered Commenterde Graaf

Chris, Just tested Firefox and it worked fine, if it doesnt work next time you try it let us know and we will enter you from this end.

October 25, 2008 | Unregistered CommenterGold Prices

Sir,

If investor are deleveraging to attend margin calls massively, then the chart analysis doesn´t make sense, at least until the process ended. Forget supports and break points today; is a nonsense.

One more thing. A warn for inexperienced options traders. Be careful. Sir, you bring me the opportunity to show a risk that everybody must be aware. There´s a thing call "time decay" which means, for a bought option: during the first two thirds of his life-span before expires, it lose 1/3 of it value only because time passing; and when the option left only 1/3 of his life-span, the option loss 2/3 of its value in an accelerated pace.

Therefore: your bought calls or puts, to break-even the underlying must go up a lot more than when you bought it months before. They do not behave lik stocks in this sense. As a rule, market makers ussualy close any open bought position once the midtime has arrived.

By the way, my congrats for your blog.
Gold makes sense.

October 25, 2008 | Unregistered CommenterChimera

de Graaf:
Could you be more specific on what you are talking about concerning Euros? Are you holding Euros now or waiting for a plunge and a buying opportunity to turn them over at a later date? thanks.

October 25, 2008 | Unregistered CommenterChris Kern

Chris. If deflation would really occur in the short term, in my view the overnight rate must be at zero percent.
We all understand that one day, the dollar inflation will hit the dollar currency when growth returns. So lets say we have a relatively short period of deflation in the USA. Then if you buy (don't lend them) dollars with euro currency (which is getting weaker now due to recession) you 'earn' interest equal to the deflation rate. Where a nominal amount of dollars at a deflation rate of say 1 percent is worth more after one year. That is if the euro currency remains weak or equal. Then you earn min. of 1 procent a year just by holding an amount in dollars on the bank. But deflati0n has its own spiralling effect towards lower prices and delayed expenditures, so deflation rate will probably be larger, even 10 percent a year. Lets hope it is avoidable, because you would probably loose your job, aswell as probably 25 procent of the rest of America.
See 1930's events.

One comment with Chimera, who makes some good points here.
Technical analysis has no meaning in this kind of market behaviour. Technicals are used for short term trading and with this kind of volatility we see today, is just plain nonsense really.

The options trade is very tricky indeed with the time decay mentioned by Chimera. Its better to use turbo's and speeders, that can be sold at any moment in time. And multiply the aimed volatility of the markets.

A possible smarter way to use the option market today is by selling puts into the market. You earn a premium straight away by selling an put option. If you only buy these options with quality companies that cannot go bankrupt, you can either buy the underlying stock at the given put value when it hits. Or the value remains above the put value, and thus you simply collect only the premium and you make a small profit. In both ways you make money. Holding quality stocks for the long run and/or by receiving the premium.

Greetingz

October 25, 2008 | Unregistered Commenterde Graaf

For what it is worth, many analysts have said that the key sign of a resumption of the bull market in gold will be when it de-couples from the dollar. One day is just a day, but on Friday gold moved up, after a brief downturn, while both the dollar and the yen soared. This could be a harbinger of what we are expecting, and eventually the stocks should follow. But I fear you are right about the timing -- Donald Coxe has been the sharpest analyst of overall trends for some time, and he talks about a "slow movement' in a three-movement symphony which characterizes bull markets of any sort. This slow movement, or major correction, in commodities is likely going to take more than a year, though, not the original expectation of a few months. IF the longterm trend favors commodities over paper, and precious metals for both financial and fundamental reasons, we should be able to look back at this mess in 5 years and regret we wasted so much anxiety on it. If the big picture is wrong, and we get into a decade or more of global recession, well, those of in this sector can always plan to work forever,and forget about retirement funds! And NO ONE will make any money other than the old fashioned way, ie working, and that might not be such a bad thing in the long run...

SRG

October 26, 2008 | Unregistered CommenterSRG

http://www.commodityonline.com/news/Shortage-of-Gold--Silver-in-precious-metals-market-12406-3-1.html

"The Slogan: Delivery in December or “DID”

Okay, fine, if the two or three big U.S. banks that have savaged the gold and silver markets on the COMEX with an avalanche of short sales since July have so little respect for gold and silver that they are willing to sell them down into oblivion - when there is a raging shortage of metal in the real bullion marketplace – then shouldn’t some of us take them up on it?

In other words, if the COMEX doesn’t respect the real physical market for gold and silver, shouldn’t we remove the metal from them and send it into the physical market that does respect it? This report says yes, certainly we should. They are figuratively begging us to.

Apparently that exodus of metal from the COMEX is already underway. For example, just over the last five trading days 2,051,970 ounces of silver were withdrawn from COMEX warehouse stocks and delivered elsewhere. The total inventory of silver fell from 133,582,226 to 131,530,256 ounces for the period. And, that’s during October, an “off month,” or relatively light-contract month.

There are persistent rumors in trading circles that an unusually large number of long contract holders intend to stand for delivery in December for both gold and silver. There is good reason for that. Bullion dealers desperately need metal to fill mushrooming customer orders.

Assuming one wants over 100 ounces of gold or 5,000 ounces of silver, how does one buy gold or silver on the COMEX and take delivery of the metal? I asked Tony Klancic of Chicago based futures broker Lind Waldock for a primer on the subject. Just below is his response via email in its entirety. For those who are interested, Tony’s contact information is included.

Again, if the COMEX is determined to under price its physical metal, then they ought not to mind seeing it leave their warehouse for the popular physical market."
********************************************

Perhaps this is just a mirage of salvation of the coming calvary to the rescue. But something tells me that we are going to give them a December to remember for a long time.
The same article mentions that over 2 million ounces of silver had been drawn down this October to date. Also it bears mention that October is usually a relatively light
delivery month.

October 26, 2008 | Unregistered CommenterDavid

A small correction on my part. I mentioned selling put options in the market. In my further going text I used the word; buy. Logically that should be; sell.

[quote]
"A possible smarter way to use the option market today is by selling puts into the market. You earn a premium straight away by selling an put option. If you only **buy** these options with quality companies that cannot go bankrupt, you can either buy the underlying stock at the given put value when it hits. Or the value remains above the put value, and thus you simply collect only the premium and you make a small profit. In both ways you make money. Holding quality stocks for the long run and/or by receiving the premium." [end quote]

Don't buy puts. Sell them is what I meant.

October 26, 2008 | Unregistered Commenterde Graaf

Dear Graaf, selling puts in this environment, is like free sex in AIDS time; unless you are a seasoned market maker specialist and know how to insure your position. Are you sure is what you meant?

About a eventual default in december gold delivery (Dear David), I personally would only bet on a home run if got insider information. And, be sure, when a information like that is running for free everywhere, think the opposite is also a possibility. Nevertheless, to whoever likes such bets, makes sense to risk a portfolio small portion (3% or less) on home runs. Otherwise, allocating more, you may lose your shirt.

October 26, 2008 | Unregistered CommenterChimera

Today is the day in the Hindu Calendar when Hindus around the world buy the gold. Due to global economic downturn, which has also impacted wholesale gold purchases by jewellers in countries like India with large Hindu population. For example, some of jewellers that I have contacted in India have told me that they have been recycling scrap gold to avoided buying new stock of bullion as customers are demanding large discounts on jewellery due to tight cashflows. The customers would rather reduce their debt than buy jewellery during Hindu Festival of Diwali. This has promted some 300 million middle class indian to reduce spending on jewellery unlike past two years. Secondly, the recession in the US and now in europe will further reduce the spending power of indian consumers, as they are worried about the impact of said recession on call centres, IT consultants, Textile workers, and so on, who has benefited from economic boom we have enjoyed in the US and Europe. I am therefore going short gold and long greenback. However, if the gold reaches $550 to $575 range then I see this as a buying opportunity. Some central banks may find this range an opportunity to dump Euros and worthless sterling and buy gold.

October 26, 2008 | Unregistered Commenterstocktaker

For what it is worth, many analysts have said that the key sign of a resumption of the bull market in gold will be when it de-couples from the dollar. One day is just a day, but on Friday gold moved up, after a brief downturn, while both the dollar and the yen soared. This could be a harbinger of what we are expecting, and eventually the stocks should follow. But I fear you are right about the timing -- Donald Coxe has been the sharpest analyst of overall trends for some time, and he talks about a "slow movement' in a three-movement symphony which characterizes bull markets of any sort. This slow movement, or major correction, in commodities is likely going to take more than a year, though, not the original expectation of a few months. IF the longterm trend favors commodities over paper, and precious metals for both financial and fundamental reasons, we should be able to look back at this mess in 5 years and regret we wasted so much anxiety on it. If the big picture is wrong, and we get into a decade or more of global recession, well, those of in this sector can always plan to work forever,and forget about retirement funds! And NO ONE will make any money other than the old fashioned way, ie working, and that might not be such a bad thing in the long run...

October 26, 2008 | Unregistered CommenterAnon

From Chimera; "Selling puts in this environment is like having free sex in AIDS time..."

Nice figure of speech, :) But I'm serious.

No, I'm not the seasoned market specialist, but in my view its a very savvy way of obtaining good quality stocks in a time of high volatility for 2 reasons.
1. You are able to obtain your preferred high-quality stock for maybe the lowest price around and collect a premium for it.
2. If the stock doesn't trade below the put value, you keep the premium, free and clear.

Just seems logical to me. Only thing is to find a stock that really is high-quality and practically cannot go bust.

Hope this clarifies

October 26, 2008 | Unregistered Commenterde Graaf

Regarding deflation/inflation, I see both happening - first deflation and then inflation. The question is when will the turn happen?

Care to read the following?

http://www.moneyandmarkets.com/burning-question-wont-this-all-be-inflationary-27751

http://www.theglobeandmail.com/servlet/story/RTGAM.20081024.wdecloet1025/BNStory/SpecialEvents2/

October 27, 2008 | Unregistered CommenterJJ

JJ, Sorry we are late publishing your comment - it got caught by the Spam catcher and we have just spotted it!

October 27, 2008 | Unregistered CommenterGold Prices

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