Traders like to talk about panics or crashes–“The Panic of 1907” or “The Crash of 1929.” Usually crashes involve something dropping in price. I have this funny feeling that the panic of 2011 will be upwards. There has been a slow move into hard assets for years now. One by one, investors are beginning to understand the meaning of what the Federal Reserve intends to do to our currency. Even more importantly, investors are beginning to understand that most Western governments are effectively bankrupt. None of this should be news to anyone. What is shocking is our government’s blasé attitude to the mess it has created.
We are now wrapping up a very contentious period of debate about the budget. After threatening to shut down our government, both sides agreed to cut a few dollars and go on with the status quo. It reminded me of an insolvent company deciding to save money by eliminating free coffee. If I were a creditor to the US, I’d be in a blind panic. I think many people are suddenly realizing that the system is broken and no one has any desire to fix it.
For the past few months, gold has gone up, even while Fed officials have threatened to stop QE2 before it was scheduled to end. I think that’s telling. Gold knows what’s going on. People are slowly waking up to its charms.
Fear is a strange emotion. Normally, when people are scared, they sell assets for dollars. What does a crash look like where people sell dollars to buy gold? “Get me something to own that the government will not destroy!!” If you think your currency will be worthless, there’s almost no price that’s too high to pay for gold. In the past, there was always another currency that you could buy. Argentines had dozens of options each time their currency collapsed. What if there are no other options? All the currencies are now bad.
I realize that the concept of an upwards crash is strange to people. Look at what happened to the CBOE volatility index (VIX) from late 2007 until 2009. I think gold is about to do something very much like that. The days of slow and contained gold moves are over. We are about to see some real volatile action. What will people do if gold has a $100 one day move higher? Will they panic out of other asset classes to buy more?
Everywhere I look, gold is one of the most hated asset classes—even though it is at multi-year highs. Gold futures open interest is down from highs a few months ago. Open interest in the Market Vectors Gold Miners ETF (GDX: NYSE) is near 2 year lows. These are products that traders use to get exposure. No one cares about gold yet. I think that the doubters are about to suddenly become believers.
A smart friend once told me that if you want to write about the market, you should never predict an event and a date simultaneously. I have always said that this bull market in gold will not end until there are $200 dollar up days in gold. You need something so shocking that it scares the politicians to stop acting stupid. I’m not saying that I know what gold will do next week, but I think we’re on the cusp of a real paradigm shift. Some time very soon, people will have no choice but to panic. We are getting very close to the first flash crash higher in gold. There will be plenty more flash crashes to follow.