Gold means lots of things to lots of people. To some, it is a store of value, to others; it is a barbarous relic from a long-ago era of archaic finance. To some, it is a day-trading product, to others; it is meant for jewelry and little else. The issue with gold is that it has lots of personalities. Those personalities are the embodiment of those that are buying and selling it on any given day. Sometimes, those personalities are in balance, sometimes one of them takes precedence. At the same time, unlike many investments, gold has no intrinsic value—no earnings, no book value, nothing to place a price upon. It is just a trading price and little more. The price is just a composite of the investing world’s mood.
I like to think of gold in terms of production cost, at least that lets you ground your thinking in something empirical. The problem is that in the short-term, commodities can and often do trade below the marginal cost of producing them—like gold currently does. So, in the end, gold is not tethered to any real value. It floats based on emotions and margin calls.
Nowhere is this more apparent than the daily trading in the futures market. In 2011, traders were enamored with gold and it briefly traded up to $1,900 before settling into a range between $1,600 and $1,800. At the peak, large traders were long 262,000 net contracts. As of the last report, large traders were long only 33,000 net contracts. Meanwhile, the large speculator short position is one of the largest ever. What changed? Nothing except psychology. Leveraged futures traders had stops triggered, or they faced margin calls. Meanwhile, chartists have noticed a pretty obvious declining chart and piled in on the short side.
A similar thing has happened in the gold ETF where holdings have gone from 43 million ounces at the start of the year to 31 million ounces today—a stunningly large drop in investor holdings. Where did this gold go? It went into the hands of long term investors in physical gold—it was made into jewelry—it was deposited in the vaults of central banks. This gold isn’t coming back into the market in a hurry. It has gravitated into stronger hands.
GLD ETF holdings in ounces
We have to remember that gold trades on a market with many leveraged traders. These traders have emotions and they have margin calls. Gold can trade erratically and in the short term, it can trade at almost any price. Over the long term, gold will continue to go higher—if only because the world’s central banks continue to print more money. In the short term—who knows??
The last few months have been frustrating for many of us gold owners. I have to think that we are nearing some sort of long-term and lasting bottom. Bottoms are created by true wash-outs in terms of sentiment, massive sales by non-believers who bought late in the move and reduced production as mines are shuttered for being no longer economic.
I’ve already noted the massive sales from leveraged futures traders and ETF holders. Let’s talk about sentiment as—this is a true wash-out. According to market vane, at the end of May, gold bulls were down to 40%, the lowest reading since 2001 at the end of the last bear market. Since then, gold has dropped another 15%. Where is sentiment now? For a point of reference, at the lows in 2008, sentiment bottomed at 53% bulls. Another popular gauge now shows that gold newsletters—the people who market to gold investors—are suggesting that their readers be net short. Have you ever met a lot of retail gold investors? These guys aren’t they type that sell their gold. A whole lot of true believers are now either on the sidelines, or short. This will be rocket fuel when the trend does turn.
I have seen many wash-outs over my life. After a certain point, the selling just begets more selling. There is no rational reason for this. Instead, margin calls are exacerbated by longs who cannot take the pain of losses. We are in a world where portfolio managers are asked to produce performance daily. How long can you hold on when your position keeps dropping? The trick if you believe in an asset that is experiencing a wash-out bottom is to stop watching the daily action. These wash-out moves tend to be the most jagged and erratic at the very end of the move—it’s counterproductive to try and guess the exact low and you will probably be wrong before you are right. Keep some powder dry, but if you liked gold in the $1,600s at the start of the year, you must really love it in the low $1,200s.
There is no way to know if the bottom is in, but for long term owners, this sure creates a lot of opportunity. Let’s just say that I’m pretty long...