On the crash in gold

Gold is breaking down in a big way right now. We are well into bear market territory here.

Marc Faber thinks it could fall to $1300… before rebounding. A number of noted goldbugs are talking about a Fed conspiracy. So what is going on here? Personally, I like the way Pawel Morski puts it.

Gold – unlike bank deposits, equity or bonds, or even banknotes – it’s separate from the real economy; it’s what you invest in when you want to take a breather from what’s happening in the real economy. That’s actually only a sensible thing to do in pretty extreme circumstances. Gold returns are utterly crushed by equity markets in the long term – to a really astonishing degree for those economies where we have continuous equity markets. Compared with shares in pre-revolutionary China or pre-war Poland, gold returns look pretty good. 

I have been saying that the gold bull is over – at least for now – since the beginning of 2012. In my ten surprises for 2012, I put my prediction of a gold bear this way:

“Gold continues to lose its luster: gold wins when financial repression, defined as negative real interest rates, is the greatest. The higher the gap between inflation and long rates is, the higher gold will go because it goes from being a burden that has zero yield to being an asset that holds purchasing power amid government-sponsored wealth destruction. I think the inflation cycle has peaked. European inflation is coming down, Indian inflation and Chinese inflation are coming down. And policy rates, particularly in the US and Europe have no room to go much lower. That’s not gold bullish.”

And this continues to be the case. Rates cannot go any lower and inflation expectations are not coming unanchored. That’s my view.

Below is what Marc Faber, a gold bull, is saying. And, interestingly, he too is noting that the breakdown in gold could be signalling that inflation expectations have peaked and deflation is a threat. What will the response of central banks be if this threat turns to reality? I believe that response would be aggressive and then the question would turn to the difference between paper and physical gold in a period in which confiscation is increasingly on the political agenda.

Source: BLOOMBERG TELEVISION

Faber on the fall in gold prices:

“I love the markets. I love the fact that gold is finally breaking down. That will offer an excellent buying opportunity. I would just like to make one comment. At the moment, a lot of people are knocking gold down. But if we look at the records, we are now down 21% from the September 2011 high. Apple is down 39% from last year’s high. At the same time, the S&P is at about not even up 1% from the peak in October 2007. Over the same period of time, even after today’s correction gold is up 100%. The S&P is up 2% over the March 2000 high. Gold is up 442%. So I am happy we have a sell-off that will lead to a major low. It could be at $1400, it could be today at $1300, but I think that the bull market in gold is not completed.”

“$1300. Nobody knows for sure but I think the fundamentals for gold are still intact. I would like to make one additional comment. Today we have commodities breaking down including gold. At the same time we have bonds rallying very strongly. If you stand aside and you look at these two events, it would suggest that they are strongly deflationary pressures in the system. If that was the case, I wouldn’t buy stocks or sovereign bonds because the stock market would be hit by disappointing profits if there was a deflationary environment.”

On gold falling lower if we have a deflationary environment:

“Yes, I agree. That’s why I said if the gold market collapse is saying something about deflation and at the same time we have this sharp rise in bond prices and the signals are correct that we have deflation, I wouldn’t buy stocks because in a deflationary environment, corporate profits will disappoint very badly.”

On whether a deflationary environment is possible right now:

“Everything is possible…In the economy of the cuckoo people that populate central banks, everything is possible. What you have is gigantic bubbles, the NASDAQ in 2000, then the housing bubble and then commodities in 2008 when oil went from $78 to $147 before plunging to $32 within sixth months. That kind of volatility comes from expansionary monetary policies from money-printing.”

“All I’m saying is that I think we’re going to have a major low in gold in within the next couple of weeks. Gold, as of today, you should actually buy as a trade. I think it can rebound in the next two days by $40.”

On why gold will rebound $40 in the next two days:

“Because we are about in gold as oversold and we were essentially during the crash in 1987. From there we have a strong rebound. All I am saying as a trader I would probably enter the market quickly for a rebound of $20 or $40. From a longer term perspective, I would give it some time. We may go lower. I am not worried. I am happy gold is finally coming down, which will provide a very good entry point.”

On whether investors should also stay in cash:

“My argument is that you should always have in this kind of high volatility environment a fair amount of cash because opportunities will always arise again and again and if you have cash you can then buy assets at a reasonable price. I think Patience is very important in this environment. The question is, how do you hold your cash? Hopefully not with a Cyprus bank.”