The 4 Reasons to Skip Today’s Gold Rush

In the spirit of not suffering from confirmation bias, in today’s Notes we will try to make the bearish case against gold. So before you storm Notes HQ in Buenos Aires craving blood, hear us out. Many of our staff here love gold and have long term holdings.

This issue is entirely in the contrarian spirit of playing devil’s advocate. So put your pitchforks down. Take a deep breath. There is plenty of space to poke holes in (or rant) about our thesis by writing to info@contrarianprofits.com

So here it goes. The four reasons you shouldn’t buy gold today…

Reason 1: Did you know that the seventh largest holder of gold in the world is not a country, but an exchange traded fund? Yes, gold ETF SPDR Gold Shares (GLD) has amassed the seventh largest gold reserve in the world. This fund holds more gold than China, Switzerland, Japan, the United Kingdom or the European Central Bank.

So why does this matter? Because should big investors (hedge funds, pension funds) who hold this fund (and many due), decide to dump their shares or are forced to liquidate their holdings because of investor redemptions, who will buy up the excess slack? This excess supply would surely drive the price of gold down making for some unhappy gold bugs.

Reason 2: Gold is overbought at today’s price level. When anything becomes overbought quickly, as gold has in recent months, it has a habit of correcting just as quickly. According to Bob Prechter, CEO of Elliot Wave International, the precious metals are “heavily overbought” and the “path of least resistance” will be to the downside for many months. “[Gold's] going to go much further [down] than people think.”

While gold stocks have recently pushed their 200 and 50 day moving averages higher, which is a bullish indicator, the threat that speculators are leading the way is ever present. And if the current recession takes a double dip, which we think is highly possibly (and so does Nouriel Roubini), investors around the world will flee to the dollar again. When the dollar gets propped up, gold falls. And when it starts to fall, you can bet these speculators will be abandoning ship just as fast as they boarded. This could leave you, dear reader, with a sinking boatload of gold in the middle of the vast and hopeless ocean.

Reason 3: More inflation hedges are available today. In the past, gold served as the best inflation hedge out there. In the 1970s when inflation started taking off, so did gold. People piled into the precious metal at rates never before seen, driving the price up to historic highs.

Fast forward to today, and you have a much different investing environment. Gold’s monopoly as the only inflation hedge is over. Now, investors have a wealth of options such as currency ETFs, TIPS, short US Treasury ETFs, other baskets of commodities, and stock in companies that can raise prices on pace with inflation. While none of these vehicles is the perfect inflation hedge, each attracts money away from gold. And the less demand for gold, the less upward price pressure there will be.

Reason 4: The run up in gold is based on fear, not on increased demand. Right now, owning gold is a “fear trade.” The price of gold is not up because people are buying more jewelry or Indian saris. It’s up because people are scared of hyperinflation taking over, the mountain of debt crushing the US, and the fiat money system collapsing. But what if Chairman Ben, and all his merry henchmen, are actually doing the right thing? While it is hard to say this with a straight face, what if everything returns to normal and we experience a nice V-shaped recovery? Or, more plausibly, what if deflation wins the day? Both these scenarios will have serious downward consequences on the price of gold.

So, dear readers, what do you think? Are any of these scenarios possible? Write to us at info@contrarianprofits.com