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In addition to being a commodity, gold is also a cause. As the latter, its recent surge to record highs stands as an indictment of the paper money system that helps underwrite the fiscal and monetary irresponsibility of government, and the need to replace that system with the discipline of sound money—literally, money that actually makes a sound.
I support that cause, but what we sound-money advocates would prefer to see must be distinguished from what is likely to happen. The roaring bull market in gold seems ripe for a downside correction—assuming it didn’t already begin with the $100-plus selloff from Monday’s high.
According to the metals-consulting firm CPM Group, if gold were bought only for its industrial and ornamental uses—the attributes that make it a commodity—its price would run about $600 an ounce today. The last time gold saw $600 was nearly five years ago (see chart below), so other factors must have propelled the price to highs of more than triple that level. The main factor has been net buying by investors, aided by the advent of exchange-traded funds that make it easy to acquire the metal.
What exactly are these investors investing in? Mainly the concerns that help make the metal a cause: the lack of confidence in the ability of governments to manage their monetary and fiscal regimes, causing a flight out of paper money—including dollar, euro and yen—into the only major safe haven left, gold.
Despite the justifiable lack of confidence, recent price behavior to the record high of $1,897 early last week might give any gold bull pause. Even if prices recover from the subsequent selloff, chances are that further peaks will be short-lived. Look for prices to remain in a holding pattern at best, with the next major move probably favoring the bears.
One such bear is Steve Briese, publisher of the Bullish Review of Commodity Insiders newsletter and Website. Having strongly recommended long positions in the metal early this year, Briese (pronounced “breezy”), recently put out a virtual S.O.S. to his subscribers. In the Aug. 15 issue of the newsletter, he called the daily gold price chart “as close to straight up as you can get without going vertical,” and then warned, in uncharacteristically emphatic language: “These charts always, always, always end with prices going down, down, down for a long, long, long time. Always.”
BASED ON EXTENSIVE research he did for Barron’s about the performance of similar roaring bull markets, which rose and then collapsed, Briese believes a 33% correction from recent highs, to about $1,250, is quite plausible.
Bolstering his conviction that the gold chart illustrates a classic speculative bubble, Briese further points out that the long side of the vast futures and options market has been in “weak hands.” Based on the Commodity Futures Trading Commission’s weekly “Commitments of Traders” report, he notes that the net short position of traders whose business involves dealing in actual gold has been at near-record levels over the past few weeks. In other words, the smart money, while not always right, has been voting with its dollars that gold will fall. It has mainly been the speculators who have been voting for a continued price rise.
But not wishing to overly bug the gold bugs, he recommends only that they consider taking profits and then wait to buy back eventually at what he believes will be much lower prices. This is a similar prediction to the one Briese made for commodity indexes in the March 31, 2008, Barron’s cover story. In that case, he was proved right by year end.
Whether or not this view does prove right, caution about the upside does seem in order. Take, for example, a frequent argument made by the bulls that gold should at least reach an inflation-adjusted high of $2,330, a figure derived by taking the January 1980 peak of $850 and upwardly adjusting it for the rise of the consumer-price index over those 31 years.
But if the gold price really should track the CPI, why, for example, did it fail to do so from 1985 through 2000—which saw a 15-year decline in gold, while the CPI rose by 60%? The answer is that gold responds not so much to inflation as it does to economic instability in general—and these were 15 key years in the two-decade era of the Great Moderation, when the economy was relatively stable. Of course, economic instability often includes price inflation, but mainly when it’s accelerating or running annually in the double-digits.