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A Theory Of Gold (GLD)

12/06/12 by  
Filed under Bourbon & Bayonets

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There’s nothing like a few words about gold to bring old Aunt Harriet storming out of the batcave with a rolling pin in her hand.

So it was after last week’s letter, in which we heard from numerous batty types that gold was certain to rally into year end.  This is Indian buying season isn’t it?  Chinese New Year?  And don’t forget Minoan child sacrifice month!

Har, har.  You old bootlick.

To reiterate, we reported last week that…

GLD sits a mere 3.5% above the support area at 161.  Should it drop below that level, 161 would then become resistance.  Note, too, that when moving averages are gathered as they are for GLD, it becomes easier for a single day’s move to slice through support and change a stock’s complexion entirely… [A]ll goldphiles [should] keep an eye on GLD 161.  Any move below that level would likely be a game-changer.

The action since last week has brought us closer to that all-important 161 level.  Then, GLD sat just below 167.  As of yesterday’s close, we’re three dollars lower at 164.  Support sits just 2% below our current price.

And the bulls still cry “Quantitative Easing!”

Where’s the Truth?

In the never-ending battle to understand which way gold is headed, we offer the following for your consideration.

It’s a daily chart of GDX, the popular Market Vectors Gold Miners ETF, since it began trading back in the summer of 2006.

Most important for us are the notes in red.

At the bottom of the chart, you can see that at no time in GDX’s history did RSI register so highly overbought as it did at the September highs eight weeks ago.  Since then, price action has been straight down, with GDX forfeiting roughly 18% of its value.

RSI and MACD are both trending below their waterlines (in black), indicating we’re in the grip of a full bear move.

And though we have to admit that the miners did a yeoman’s job of rallying off their July lows, putting on nearly 38% in a bid to retake their last retracement high at 58, alas, the effort was in vain, as the six month chart below shows.

GDX ran into strong overhead resistance at the long term, descending moving average at 55 (yellow line, blue annotation), and that’s where things were capped.

GDX investors now face a dark future.  With all moving averages trending lower and shortly to be fully unwound, and with the stock itself falling and currently below all its moving averages, and with both RSI and MACD indicators below their respective waterlines, how could anyone possibly believe the future for GDX is golden?

And maybe more importantly, who’s telling the truth?  The GDX miners?  Or GLD, the metal?

Because according to the GLD chart, we’re still holding above three of four important moving averages, albeit just by a whisker.

The Rough Edge of the Truth

There are two possibilities.

Either A) the miners are just waiting to play catch-up, or B) they’re leading, and it’s the metal that’s about to take a spill.

Let’s examine them both.

To Review

Mining stocks are leveraged to the price of gold.  If it costs $800 to pull an ounce of gold out of the ground, and gold is selling for $900, the miner’s profit is $100.

But if the price of gold rises to $1000, the miner’s profit doubles to $200 (from $100), and his share price should rise accordingly.

Did you catch that?

The price of gold rose by 11% (from $900 to $1000), and the miner’s profit (and share price) grew by 100%.

Miners’ share prices move on earnings, and earnings are affected by the price of gold itself.  Which leads us to wonder why, with gold just 10% off its all-time historical highs, we don’t have gold mining equities shooting through the roof.

And if you explain that current mine supply is dwindling and not being replaced fast enough to maintain the type of profit projections we’ve grown accustomed to (hence the lower share prices), then we have another question for you.

Shouldn’t that push the price of gold higher?  Shorter supplies mean higher prices, right?


Unless the truth lies elsewhere entirely.

Is it fathomable that the price of gold simply got extended and is now returning to a level more in line with the profit reality evinced by the miners?  And, if so, is it possible that the “appropriate” level for gold is actually closer to $1000 today than $2000?

We think so.  But either way, the gap that opened between the two back in mid-2008 will have to close over the long term.

Have a look here:

The two decoupled in the middle of 2008, and since then GDX has gained 15%, while bullion is up almost 150%.

Others will have their explanations.  We don’t buy them.

Best play it with a long-short initiative, buying the miners and selling the metal.  And if you’re using options, go out as far as you can.  This may take some time.


Many happy returns,

Matt McAbby

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25 Comments on "A Theory Of Gold (GLD)"

  1. Arthur Cortis on Thu, 6th Dec 2012 7:32 PM 

    Miners are the play for the future although bullion will surge somewhat from current levels………………..but miners will explode………………….for patient investor!!!

  2. Paul Sutton on Thu, 6th Dec 2012 7:57 PM 

    I’m telling readers that the decline in gold/silver prices is possibly due to the fiscal cliff or any compromise that puts our fiscal future back into saner territory. I’m assuming the rise of gold since 2002 (when it was about $280/oz) is a direct result of the 45% decline in the dollar that began at the same time, bottoming in 2008. Good for multinationals? Good for oil prices? Theoretically good for exports (oil being out biggest in $). With fiscal sanity we’ll likely also get a stronger dollar; if we ever get back to dollar 120 in DXY then we should also expect gold to fall back to $280. If you’ve got 10-years of profits based on a debased dollar then you should also anticipate what will, or has already begun happening, if the dollar should regain strength. Historically, gold is a terrible investment, even during inflationary periods. But pound the dollar down and gold (and crude oil) will fly like helium-filled balloons. Historically, eventually the dollar regains its strength, and gold and crude both crawl back into the woodwork for another 20 years. It’s not complex, nor unprecedented (think 1979).

  3. ken on Thu, 6th Dec 2012 8:22 PM 

    Gold could drop to $1000.00 if we head into a severe recession and if governments stop the bailouts.
    This is possible, but would the public accept this austerity?
    Show me the money honey will be the cry!
    Gold will likely rise to $2000.00 before $1000.00.

  4. Frank on Thu, 6th Dec 2012 8:39 PM 

    I appreciate the technical analysis, but what about a discussion about the pricing of gold as it relates to the relative strength of the dollar. Most often, when the economy is not full of fear, gold moved inversely to the dollar. What can change that picture?

  5. Patrick Slater on Thu, 6th Dec 2012 8:45 PM 

    Cost of capital, lower ore grades, fewer large discoveries, poor management decisions, all these are baked into the mining companies share prices and go a long way towards explaining the under performance you illustrated so well.

    What you anlaysis leaves out is the continued Western Central Bank printing of dollars and Euros and Eastern Central Bank buying of the physical. The Western CB’s have no choice but to sell their gold to the Eastern physical buyers. Should they decline to sell the physical, the price of gold goes through the roof and the value of Western currencies goees through the floor along with their bond markets.

    We are going through an ugly time in PM mining stocks to be sure. This will eventually be fixed when the Western CB’s are no longer willing or able to sell their physical. The miners will have their day in the sun then and few will believe how powerful the move will be.

  6. Vincent on Thu, 6th Dec 2012 9:34 PM 

    The price of gold is under very strict surveillance since Nov. 2008 and is manipulated by central banks around the world so that its price increases remain under control.
    Ask what Eric Sprott thinks about it.

  7. Richard Elie Maseri on Thu, 6th Dec 2012 10:06 PM 

    BINGO Matt! Hit it on the head ole boy! GLD @ $161 is the knock-out, lights out, magic number! On the same page here. My models are in “Sell” mode and have me short both Feb. Gold Futures, $GCG13 and the $GLD, with AU’s initial downside target @ $1632 then $1537 /per oz.
    GLD’s equivalent numbers are @ $154 & $143 respectively, this wave structure / sequence.

  8. Michael Miller on Thu, 6th Dec 2012 10:58 PM 

    You appear to be of the opinion that cutting down a tree, adding some ink, and calling it a billion dollars has more value than a limited asset that has held purchasing power for five thousand years. Gold will continue to rise in value, when measured in dollars, simply because dollars are being created at a far faster rate than gold is being mined.

  9. Chipster on Thu, 6th Dec 2012 11:03 PM 

    I vote for the cute one for your aunt. I don’t have the expertise to say whether GLD declines or the GDX rises, but just writing to say I enjoy your periodic opinions and writing style.

  10. matt oconnell on Thu, 6th Dec 2012 11:09 PM 

    The gold flooris$1700.
    Below that, the central banks increase their buying.
    Jan 1st they count gold as 100% value instead of 50%

  11. DJMpawn on Thu, 6th Dec 2012 11:34 PM 

    Helicopter Ben keeps printing and printing more dollars and eventually he has
    to pay the piper. Maybe in the short time it goes down marginally but in the long term I see gold much higher, say 2000 buy the end of 2013.

  12. Ron Smith on Fri, 7th Dec 2012 12:06 AM 

    Ok, I’m officially confused by the sell gold, buy miners recommendation. If the value of miners is based on the price of gold, and the price of gold falls, wouldn’t the miners fall as well? Wouldn’t the price of gold be driven by currency value and demand, while miner value would also include production costs. Wouldn’t it be possible for the price / demand for gold to stay roughly the same while production cost increases dramatically thus creating a divergence? Just curious.

  13. A.M. Deist on Fri, 7th Dec 2012 2:25 AM 

    Forget about GLD and other paper products. The metal with respect to the U.S. dollar will be going much higher after either 1. The U.S. defaults on its debt or 2. The other countries in the world disconnect themselves from the U.S. dollar. There is also a possibility that gold will become a standard for U.S. currency again.

    Secondarily, there are more than 100 countries in the world that have started using Argor Heraeus Kinebars in the small amounts like 1 and 2 gram bars as a medium of exchange. That will soon be coming to the United States.

    All that said, the opportunity in oil is much greater than the opportunity in gold. If gold goes from $1700 to $2000 an ounce, that would be a 17.6% gain. If oil goes from $85 to $100 a barrel, that would be the same 17.6% gain. My money says there is a much greater likelihood that oil will hit $100 a barrel or greater before gold hits $2000 an ounce.

  14. M.Procope on Fri, 7th Dec 2012 7:23 AM 

    I want to so thank you for your thoughtful ideas.

  15. Olesen on Fri, 7th Dec 2012 8:52 AM 

    The Price of GLD and GDX depends ( among other possible variables ) but to a high degree on the INTEREST RATE and thereby on the PRICE of BONDS .
    Will ANGLOSAXONIA be able to KEEP INTEREST RATES DOWN at HISTORICALLY LOWS ( 240 /340 Years LOW ) … or will they NOT ? considering these 2 countries INSATIABLE APPETITE for BORROWING ABROAD and borrowing without which Anglosaxonia will go BANCRUPT . ..THAT is MY ANSWER to the Question where GOLD and related Prices will go

  16. Bob Duch on Fri, 7th Dec 2012 9:06 AM 

    A really good question you bring up. I suspect the price of gold is more “correct” than the price of GDX. I believe we will keep printing (as will everyone else). In the 80’s gold bubble the world’s buyers were North America and Western Europe. Nobody else had money to buy gold. Now there is closer to a worldwide market of buyers. With virtually all countries devaluing to remain competitive with exports it seems to me that gold has to go up long term. That said, nothing says it can’t retrench 50% like it did in the last bubble. As for GDX mining has to be the world’s worst business. So much can and will go wrong. Think Cigar Lake flooding. Seems like mining management is less than stellor across the board and if a mine does everything right you then have the risk of a broke Gov. confiscating your profits. Will Navidad ever become a mine? And will Christina own it the day it starts to produce?
    Kudos to your calls and I must commend you. This is my first comment and it brought up a window saying try us, email here and your good to go. I’ll end up subscribing just based on that. Not wading through 10 pages of hype and then filling in a bunch of info (I’ve never done it and never will) tells me something. I like it.

  17. Mike on Fri, 7th Dec 2012 10:34 AM 

    Gold goes up during times of great peril….. 1929, WW-ll, 1987 and NOW…… Soon, if the economy damaging Republicans get out of the way, the economy will go up and gold will go down… They lose either way, just depends how much they want to make the average citizen suffer for voting them out of existence, just like our grandparents did in 1932…..

  18. Stephen on Fri, 7th Dec 2012 3:00 PM 

    There is only one trade for GLD, GDX, anything gold. And that is down, down, down.

  19. Bill on Sat, 8th Dec 2012 12:39 AM 

    What is gold worth in dollars is asking what paper dollars are worth. As long as people believe in the dollar as being something with value, and will sell you something in exchange for the paper, then it has that much value. I think you should examine how much it cost to mine an ounce of gold five years ago, 10 years ago, 15 years ago, 20 years ago, 50 years ago. I do not know, but seem to recall reading it was around $400 an ounce or maybe a little more back only a few years ago and maybe 75% of that several years earlier. Let’s say it was $400 and I am still guessing. Now you say it is $800. I do not think the rise in production cost is moving in a linear fashion and seems to be accelerating in a more parabolic manner. Too prove that or disprove it, go back 10 years and then 15 years and plot it out. Put that in one of your articles.

    I question where you got the $800 dollar number from and if it includes all of the costs related to the entire process of exploration, mining, taxes, etc. to product. I have read elsewhere that we are now around 1200 or so if all costs are considered, but maybe that depends on the country and particular mine and averages. At any rate, I think it is important to accurately evaluate not only the current costs, but the trend in costs and then project from there. I think you may find that gold is not overpriced, and if it is it will not be for much longer.

    In dollar terms, from another point of view, gold is dramatically undervalued. If you take all of the gold the US government claims it has stored in its vaults. The gold it wants you to believe is there and will not allow anyone to audit, assay and verify it is there, and in fact all really gold and not gold plated tungston. Then take all of the dollars and dollar equivalents (like bonds, money market accounts, etc.) and divide that by the ounces of gold that is supposedly there, I think you would find that the number is somewhere between 10,000 and 20,000 per ounce or maybe higher by now. Unless you really believe that paper is money and gold is metal and not money, which sounds a bit insane, then you need to evaluate the value of gold in paper money by how much of each there are out there or just hope everyone keeps believing paper has value worth owning. Eventually, people or enough people will figure it out.

    Bottom line is gold is likely undervalued in dollars due to the actions of the Fed and US government over the past 100 years and especially more recently.

    If the price in dollars of gold drops from here, I will be buying all the way down and hope it goes as low as possible. If the price increases, I will still buy whenever I have a little money I want to save. At least until all of the debt problems around the world are resolved and there are sound interest bearing safe secure savings accounts or CDs I can put cash into. Right now there are non, and if interest rates begin to rise to tempt us, the ones with high debt (US, Japan, EU, etc.) will soon implode and go bankrupt causing the value of their currency to drop like a rock and the metal, as you call it, to go in the opposite direction relative to the currency. Bottom line is gold will hold its value and paper will not. When the bottom falls out, all the cash will become trash and the gold will still be there for future use with the same buying power it has held for thousands of years.

    It could be next year, or 10 years down the line before the bottom falls out, but some things just cannot go on forever. The debt bubble appears ready to explode, but it has for years now and just keeps growing faster and faster. What happens when it pops? Are paper dollars going to be worth 100% of what they were before? 80%, 50%, 1% 0.1%? This is what needs to be thought about when you talk about gold and its price compared to paper.

    Gold miners, the well managed ones that have gold in the ground and have already built the mine and facilities are likely undervalued as well and worth looking into as an investment in my opinion. Gold is only a store of value and not really an investment and miners are an investment.

    Obviously I own physical gold and some gold mining shares and have no intention of selling any of the physical gold until after the crash and maybe not even then. At least not until there is a safe and secure alternative.

  20. Chalzer on Sat, 8th Dec 2012 2:13 AM 

    “At the bottom of the chart, you can see that at no time in GDX’s history did RSI register so highly overbought as it did at the September highs eight weeks ago. Since then, price action has been straight down, with GDX forfeiting roughly 18% of its value.”

    Matt, “straight down”(boldface AND underlined)was for hyperbolic effect, right? I mean, poking fun at the ‘goldbugs’ for their heretic beliefs is richer if one can make them squirm and, in the process, have them abandon their tinfoil hat ways. That way, we can all get on the mainstream bandwagon and buy the mainstream (Wall Street acceptable) stocks.

    Well, there is a time to short and a time to go long. If one likes the volatility, one may sell it for fun and profit.
    Then there are those who believe the dollar and other fiat currencies will be sacrificed at the altar of unlimited creation to keep the ship from listing. IOW, not everyone is a loser, as you intimate.

  21. Lord on Sat, 8th Dec 2012 12:10 PM 

    As long as the American Government keeps printing money faster than the economy grows gold will increase in price.

    Look at the gold v $ purchasing capacity since the Fed was established in 1913.

  22. Franc on Sun, 9th Dec 2012 7:08 PM 

    On observation my comments are gut feeling driven.Although the gold price has maintained its new value well over 1650 U.S. the real strength in the price continues to be reflected in the uncertainty facing much of of the global economy.It is becoming more apparent the great majority of wealth is being preserved by traditional investors through increasing valuations of commodities such as Gold.It may turn out to be the one remaining certainty for much of the developed world.

  23. Tonypete on Sun, 9th Dec 2012 10:31 PM 

    FYI. From Wealth Daily. Predicts that a return to the gold standard and black market demand will cause the price of gold to soar. Hmmmmmm……….

    Screw Taxes!
    By Brittany Stepniak | Sunday, December 9th, 2012

    You’ve been reading about gold and guns ever since the election results were in…
    The two are certainly not mutually exclusive; charts for both are hyperbolic as interest in physical bullion soars harmoniously with record-breaking gun sales.

    Life, Liberty, and the Pursuit of Happiness
    Individuals are hungry for wealth in these poverty-stricken times — and nations are hungry for certainty, a way to protect their economy from currency debasement.

    People are stocking up on gold and guns to protect their families and their wealth.

    What people haven’t been talking about nearly as much is how this mentality has created a burgeoning black market for the precious metals sector.

    Capitalists and survivalists alike are making a living the best they can.

    For some, this means engaging in illegal mining activities and gold smuggling.

    The Secret Return to the Gold Standard
    A silent conspiracy will make gold a new currency on January 1, 2013.
    Central banks and governments are buying gold by the metric ton…
    If you hold any toxic dollars, here’s what you must do now to prepare — and earn a 670% windfall as gold soars to historic highs.
    The Philippines and Mongolia are two prime landmasses, rich with minerals and metals…
    Miners know this and are taking advantage of the opportunity. Mongolian gold ninjas have risked their lives to engage in one of the most lucrative gold rushes of the century to support the black market demand for gold in China.

    The Business Savvy Game
    Meanwhile, the Philippine government (much like our own) continues to pass new laws and enforces outrageous taxes to get their “fair share of other people’s sweat, especially related to mining projects.”

    After a 7% tax rate was required for precious metal sales last year, smaller producers began selling to black market smugglers instead…

    According to Assistant Central Bank Governor Manuel Torres, head of the refinery operations, roughly 95% of all gold mined in the Philippines is being sold to smugglers — and transported out of the country 100% illegally.

    Expert Simon Black explains the discrepancy between how much gold smuggling is reported and how much is actually taking place:
    In 2011, central bank gold purchases dropped at an annualized rate of 4%, then 76%, then 88% during the second, third, and fourth quarters. In the first quarter of 2012, gold purchases were down 92%. It’s staggering.

    Most of this smuggled gold finds its way here to Hong Kong, and then onward to China, where there is a voracious demand for gold despite rising prices.
    Of course, it’s perfectly legal to bring gold, tax-free, into Hong Kong.

    This is why when Hong Kong reports its official trade statistics, “gold imports” from the Philippines are 30 times higher than what the Philippines government reports as “gold exports” to Hong Kong.
    Nations like China, India, and Iran have been stockpiling silver and gold at unprecedented levels to protect their economies from the looming crisis.

    This hasn’t been easy with Western sanctions, but billions’ worth of silver and gold has been shipped to Dubai on behalf of Iranian buyers — $2 billion worth of gold was shipped to Dubai in August alone.

    Experts believe an undisclosed, but quite large, number of carriers are behind the smuggling arrangement.
    Obviously, the U.S. isn’t happy about this…

    The government is in the midst of setting up new sanctions against Iran that could force Turkey to end their “gold deal” with Iran.

    Due to global economic uncertainty, Iran demanded back in February that Turkey pay for international goods solely in gold. So far Turkey has complied, exporting “massive quantities of gold” per their deal with Iran.

    Between January and September 2012, Turkey exported at least $6.4 billion in gold to Iran (and that’s only what was officially reported). Iran has Turkey pigeonholed into this agreement, as it supplies 18% of Turkey’s gas and 51% of the country’s oil.

    Evidently, raging gold demand is creating a supply crunch that has nations desperate for deposits and mines.
    A number of international deals are under way, and a public rush for the yellow metal will clear retailers’ shelves in no time.

    This is only the beginning…
    Real gold mania is right around the corner.
    Best wishes for a prosperous future,

    Brittany Stepniak
    for Wealth Daily

  24. James Smith on Tue, 11th Dec 2012 1:24 PM 

    I recently heard GLD has some serious insurance issues:

    “Did anyone try reaching out to State Street Global Advisors and asking if GLD’s physical assets are insured? I’ve personally called them at 866-320-4053 to ask about the state of GLD’s insurance. They said that there is no insurance but at the same time they claimed HSBC bank do have insurance policies on their holdings. I could not get them to elaborate on this ‘claim’.

    There are not many ways for the average investor to validate GLD’s physical assets. Even the prospectus is full of legal writing removing liability. On top of everything, the GLD manager – State Street, has been shown to be less than trustworthy (Carina CDO, multiple instances of forex fraud). Where is the credibility in GLD?”

    I have tried and was unable to discover any specifics on GLD’s insurance for its physical assets. Why would they obscure information for GLD’s insurance?

  25. Matt McAbby on Wed, 12th Dec 2012 3:56 AM 

    Chalzer –

    As usual, you’re dead on the money.

    Your comments are well taken.

    No offense was intended.



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