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RCM Editorial: Believing in The Gold Bull Market. Does it Take Faith or Simply Common Sense?

I feel compelled today to discuss what I am hearing is the eminent demise of the Gold bull market. I have been forced to field emails, phone calls and, yes, even a text message on this topic over the last couple of weeks. To say the least, I am disappointed with some in our flock. Over the last 3 years we have painstakingly laid out the road map to perhaps one of the best bull markets in history. Gold prices have out performed all major asset classes in the last 5 years and in 2008 increased 5% while the rest of the financial world was imploding. Gold had a wonderful start to 2009 and in the last 6 weeks has pulled back roughly 10% from the highs. A well deserved rest and a necessary coiling for the 3rd assault on the $1,000 mark that will take prices to new bull market highs.

I am loath to get biblical, but I imagine my discouragement may be akin to that of Moses and his experience with the Ten Commandments. Indulge me for a moment before you roll your eyes at what you perceive to be a bombastic statement. I have basically come down from the mountain with the tablets to investing success and in a few short weeks some of our followers are dancing around a fire built by the heathens of the oft manipulated news media. In an ironic twist, instead of worshipping gold these nonbelievers have been led astray by price weakness (10% off the top would be considered small in any circle), supposed IMF gold sales and a general misguided belief that if the markets go up Gold goes down as the fear trade subsides.

Of course, this is where the juxtaposition with Moses ends. You see, believing in G-d takes faith, but believing in the Gold bull market simply takes common sense.

Has anything really changed the picture in the last 6 weeks? Let’s review:

-The tsunami of fiat currency creation around the world is perhaps the single biggest supporting factor for the Gold bull market. Have we witnessed a miraculous about face of governments around the world in the last 6 weeks indicating a tightening of credit and fiscal responsibility? I don’t think so. In the U.S., the Fed’s balance sheet has more than doubled in size since August. If you think that expansion is coming to an end you are sadly mistaken. During the last 6 weeks, instead of planning fiscal responsibility, the Fed completed an internal study condoning – in fact, encouraging – further balance sheet ballooning. And I’m not talking about the balloons on the back of a birthday chair. I’m talking about the kind that fills with hot air and carries a basket. Want details? Read this story, you will not believe it:

Fed study puts ideal US interest rate at -5% - FT reports the ideal interest rate for the US economy in current conditions would be minus 5%, according to internal analysis prepared for the Federal Reserve’s last policy meeting. The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation. A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5%. Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150 bln increase policymakers authorized at the last meeting, which included $300 bln of Treasury purchases. The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week’s policy meeting. (In order to achieve a rate of -5% interest this implies the Fed is targeting an inflation rate of at least 5% with the Fed funds rate at 0%. We are frankly surprised the study was actually made public. This policy suggests the Fed is deliberately targeting a decline in the US$, which is contrary to the government’s public rhetoric.)

-Some misguided souls have argued the fear trade is leaving the market. Apparently, the world is a safer place and that’s why gold is trading down 10%. This is such a ridiculous supposition that I find it difficult to address. During the last 6 weeks North Korea has sent a missile over Japan, the Taliban are enforcing Islamic rule in parts of Pakistan as war brews and meanwhile, our President is bowing to kings in the Middle East and forming a rather dubious book club with dictators in South America. I think the real reason for the 10% swing in Gold is really rather boring. No market goes up in a straight line. Corrections are necessary to shake out the weak holders and build a base to launch new assaults on the old highs. Since this is a mundane answer it would never work on CNBC. The news media needs to sensationalize in order to captivate. Beware, sometimes market volatility creates news, which can be misleading.

-I will conclude with a comment about the IMF Gold sales and a friendly wager. First, let me be clear, the proposed sale by the IMF is not new information and therefore was not a shock to Gold market participants. The G20 communique read, “…Additional resources from agreed sales of IMF gold…” will go to support developing countries. This is not a declaration of new sales agreements. Second, the communique read, “…To provide $6 billion…over the next 2 to 3 years…” Let’s breakdown the numbers shall we?

IMF holds 103.4 million ounces

Current value of holdings at $900/ounce = $93.6 billion

Proposed sale as per communique = $6 billion roughly 6.6 million ounces

Avg. daily ounces traded on the London Bullion Market as of Feb. 2009 = 23.8 million ounces

6.6 million ounces sold will have virtually no impact on the Gold market today let alone over the next 2 -3 years.

And here comes the wager: Western central banks scoff at the importance of Gold and attempt to manipulate the metal lower with well-timed comments and outright sales in order to continue the farce of fiat currency creation. Meanwhile, the East is buying with ever increasing vigor. If the IMF wanted to sell this 6.6 million ounces all at once China could very well be the buyer. We will wager that the day this deal is announced Gold prices will end higher not lower. In fact, we would not be surprised to see the Chinese bid a premium for the entire IMF Gold position. Curious about the Mandarin metal mandate? Look no further:

China reveals it has 1,054 tons of gold
– Reuters Reuters reports China revealed on Friday that it had quietly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tons and confirming years of speculation it had been buying. Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua news agency in an interview that the country’s reserves had risen by 454 tons from 600 tons since 2003, when China last adjusted its state gold reserves figure. The world gold market has been buzzing with talk about China buying gold for years as the country’s foreign exchange reserves have rocketed, and speculation has picked up since the global economic crisis threatened to weaken the value of those reserves. Gold prices jumped on the news and were up 1% on the day at $910.80 an ounce at 0540 GMT. By a Reuters calculation, China’s holding of gold would be worth $30.9 bln at current prices.

About Bret Rosenthal

Interpreting the news that moves markets. Principal of RCM, LLC, and founding partner of the Fortune's Favor Family of Funds
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