Is gold entering bubble territory?


I just returned from another trip to New York City. I like to spend as much time as I can there. I must say if it weren’t for all the negative media on the economy one would have a difficult time finding any sign of recession in New York. Everything seemed to be running at full capacity. Expensive restaurants, away from the tourist traps of course, were mostly full. Broadway plays full. I like browsing the high-end watch boutiques on Madison Avenue. There were many customers looking. Not sure how many were buying, but according to the woman in the Breguet shop business was brisk and many of the models with impressive complications were difficult to keep in stock. I know it is a silly status symbol to wear something on the wrist that costs as much as a more visibile and usable status symbol like a Mercedes, but they are fun to look at, much like a painting or rare coin, and it seems a good indicator of the health of the investment community.

But back to reality in sleepy little Seattle. Real estate prices seem to keep dropping. I see people still turning over the keys to the bank, with the bank offering at what seemed like unheard of prices a short time ago, with still few buyers to snap up the bargains. If they do transact at those low prices then comparables in the area will be lowered, thus driving down prices even further. I have no idea if a bottom is at hand. It seems like a good time to buy with low prices and low interest rates, but all I see are for sale signs. A few years ago you’d see a for sale sign and a week or so later there would be a sold sign attached to it. Now all you see is a new price sign (polite way of saying price was too high and now trying a lower price for the third or fourth time) and this seems to go on for a year or more for many properties.

So how does one make a case for inflation. If there are few jobs and housing prices probably not enabling tapping equity, where will pricing power come from? Will conditions improve if Republicans take over part or all of congress? The stock market seems to think so. There seems to be a bullish bias according to some studies when a democrat president has a congress from the other side of the aisle. Gridlock is good when it comes to government it seems. The general stock market seems to like the poll numbers and probably will until earnings start being released soon. But gold is entering what seems to be a vulnerable price area in my opinion. I will point out that I’m always way too early in seeing bubbles. It is very difficult to judge when greed will become overtaken by reality. It is much easier to identify a panic bottom. Tops can give many false divergences as traders are more complacent as they are making money from a rising trend. I think the bullish argument on gold makes sense from the standpoint of currency and fiscal irresponsibility. Perhaps there is hope that a change in congress will create change we can believe in regarding spending. Not sure how long that hope will last even if congress changes hands. If the past is any indication it will probably just turn out to be more broken campaign promises. But whatever happens with the election, the markets, and especially the gold market, still has to deal with the real risk of continued deflation, continued high unemployment, continued near zero interest rates with fear of rising rates at some point accompanied by a rising dollar, and an over crowded bullish trade in gold particularly, and in some other sectors of the market.

When I first started trading gold there was no gold market in the United States. One had to either trade silver, numismatic gold coins, or gold mining stocks. Back in those days there was an understanding of a normal ratio between gold and silver, and a leverage assumed between the price of gold (in London as US prices were fixed) and that of the price of the stocks of companies that mined the stuff. Many of the better trading gold stocks had about a 3 to 1 leverage to the price of gold. Most of the gold bull market letters (there were few serious stock analysts following the stocks of the barbaric relic) would advocate buying the best quality companies. The better companies had the lowest cost per ounce to mine the gold. But during the great gold and silver bull market of the late 1970’s, the best mining stocks had relatively mostest upmoves. The big winners were the crappy stocks that had very high costs per ounce. They were much more sensitive to changes in the gold price. So it is difficult to determine how much a particular stock should move based on a price change in gold, as they all moved at a different rate. But it was assumed that the mining stocks would in general lead the price of gold, both up and down. That relationship, like many inter-market relationships, seems to have fallen apart in the current environment. If relationships and ratios were stable it would be easy to make rules and systems and trade accordingly, but even then the edge would soon be lost.

Some will make the case that now there are many more vehicles to chose from if one wants to participate in the gold market, so mining stocks have less importance now than in previous cycles. One can buy an ETF without the risks of rising labor costs, environmental restrictions, unstable governments, BS from the CEO (the biggest risk imho), etc. But being from the old school of thought, I still like seeing confirmation from the mining stocks. This rally sure seems to be lacking that. The above chart shows the ETF for gold in the upper graph, and the gold stock mining index in the lower part of the chart. The last few weeks have pushed the mining index higher along with gold, but the index is still lower than the peak drawn back in March of 2008. If one were to look at an index of gold mining stock that did not hedge their production, one would getting a little better correlation between the mining stocks and the metal. Some companies sell forward some or all of their output to lock in the price, which would be fine except if the price keeps rising like it has lately, those companies hurt their earnings. But even factoring in the hedging, few mining stocks are showing leverage to the price of gold. Some of the newer mining stocks are doing better than the older blue chips as they are seen to be in their growth phase. It seems unrealistic to think in terms of growth when analysing a gold stock. It is difficult to think of long term growth for a gold mining company, at least in the sense of a Microsoft or Google when they were in their growth phases, when a company just has a hole in the ground and is depleting their limited assets every day. Well, maybe it is not as simple as that, but I think you see my point.

The relationship between the price of gold and the price of the companies that mine gold is only one piece of the puzzle in trying to figure out where prices might be heading. I read in Barron’s this weekend that one analyst now thinks gold won’t be in a bubble until it gets to over $5000 per ounce. I thought I heard people saying $2000 just a short time back. It seems when bubbles get going the numbers keep getting bigger and bigger. When markets go exponential it appear there will never be a reversion to the mean. But the mean market always does, and if it is a bubble popping it can overshoot to the other side by an even greater degree. But that’s just my opinion.

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