Debunking Some Gold Bug Predictions


"Further consolidation in gold likely to fuel a stronger breakout in August."

I must confess I am a gold bug both philosophically and in terms of investing. We are entering a golden age for gold, as the bull market is destined to reach amazing heights and real and honest money re-emerges as legal tender against fiat currencies that will soon be at the mercy of a sovereign debt crisis. All this being said, I take issue with some headlines listed here in friend Gary's blog and some gold bug talking points. I'm listing some of these headlines and talking points and here then my response.

System-Wide Meltdown as U.S. to Enter Hyperinflation
The odds of hyperinflation are extremely remote. For that to even happen, the U.S. would need to lose its status as the largest economy in the world and completely lose the reserve currency. Neither of these things is going to happen. Sure U.S. power is waning but the U.S. remains the dominant nation that is essential to the global economy. Moreover, our debt isn't owed in a foreign currency.

More importantly, if hyperinflation was even a small risk, the U.S. dollar and the bond markets would be falling apart. This is where technical analysis comes in handy. The U.S. dollar has just emerged from a bullish double bottom on the weekly chart while bonds (as per TLT and IEF) have been ripping for weeks. Their uptrends remain intact and have actually strengthened as QE has ended. The hyperinflation talk is nonsense.

Gold & Silver Have Bottomed: Summer Explosion Ahead
Gold has actually peaked at $1550 and looks headed down to $1475. It hasn't bottomed, but it is in a bullish consolidation that will likely continue into August. In terms of sentiment, silver looks excellent. Sentiment suggests a lack of material downside but silver's rebounds continue to fail and now the metal will retest $33. It could bottom at $30-$31. To conclude, further consolidation in gold will likely fuel a stronger breakout at some point but not until August at the earliest. Silver needs to confirm a bottom and build a strong base. We won't see an explosion until the market exceeds $50, which may not happen for another 12 months. First, these markets need to sustain an uptrend before an explosion can happen. It is just wishful thinking.

Hedge Funds Are Shorting Gold Stocks and Juniors
Anytime the gold stocks underperform, out comes this battle cry.

First, we need to understand that historically gold stocks do not outperform gold. Please see this excellent piece by Steve Saville which should put to rest this idea that gold stocks should outperform gold or are cheap because they are not outperforming. Gold mining is a very difficult business and it's extremely difficult the larger the company is. Even with a rising price of gold, it is difficult to sustain production and reserve growth. Hence, the sector doesn't outperform over long periods.

Sorry but hedge funds are not shorting the juniors. The juniors are extremely risky illiquid and are the worst performers when the broad market is weak. The vast majority of these companies have no production, no cash flow, no earnings and no money. They are not real businesses. They are vehicles for speculation. If your juniors are badly underperforming then you haven't picked the right ones or you have unrealistic expectations. Maybe a tiny hedge fund here and there is shorting a few juniors. Other than that, the notion is completely unproven. Consider options, warrants and private placements and then you might find the reason your juniors aren't performing.

The current reality, as we described in a recent editorial, is one of risk aversion. That is good for gold but bad for gold shares. However, gold is rising relative to mining cost inputs which will be a bullish catalyst for the gold shares in a few months and likely when this summer selloff abates.

Bonds Will Crash Without QE, Interest Rates Will Skyrocket
Bonds began another advance into the end of this QE. This is counter intuitive. If the Fed isn't buying bonds then who is? Institutions with millions need a safe place to park funds and earn a small return. Stocks and commodities have had a great run but now the ill-fated economic recovery has lost momentum. Bonds are the only place the big money can go when risk assets pullback. Remember, no QE initially means lower inflation expectations, which means lower stocks and commodities, which provides a bid for bonds.

In the Great Depression, rates didn't bottom until the 1940s. Short-term funds continue to make new highs. IEF, a 710 year ETF is on the cusp of another all-time high. There are many reasons that bonds may not decline over the next few years. The U.S. still has the reserve currency and global economic power. Weakness in the U.S. will keep short rates low and affect global economies and markets. That combination is advantage for bonds against risk assets. Japan is one example.

We expect continued debt monetization, currency depreciation and inflation but we disagree that bonds are going to collapse anytime soon.

Precious metals are certainly in a bull market and the birth of a bubble should occur sooner rather than later. This being said, we need to remember that precious metals and the respective shares are extremely volatile. The buy and hold philosophy can work with gold but it doesn't work with the gold stocks. Most companies are not even close to their 20072008 levels despite the price of gold being 50% above its 2008 peak. It is more of a bull market for traders and active investors than a buy-and-hold for 10 years' investor.

This one-way thinking with sensational statements can be dangerous and deadly to your portfolio. It is more sensible to be cautious, entertain foreign ideas and explain both sides of the coin. We at The Daily Gold have endeavored to do so and have achieved a positive return year to date when GDXJ, our benchmark is down 17%. If you're looking for more analysis and professional guidance, we invite you to learn about our premium service.

Good Luck!

Jordan Roy-Byrne, CMT
[email protected]

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