Gold : 12 reason to short gold

By | February 24, 2009

If you’re a self-professed “Goldbug,” feel free to read no further.
Or at least spare me your hate mail. Because no matter what I say
today, I know you’ll cry foul… or something much more colorful.

But for those of you with an open mind – especially after my last
three contrarian predictions proved dead accurate, read on.

Because it’s time to start shorting gold!

You won’t find many, if anyone else, making this case. But as the
first reason of 12 below reveals, that’s precisely why you should give
it more credence.

12 Reasons To Start Shorting Gold

It’s decidedly contrarian. If a contrarian investor is someone who
deliberately decides to go against the prevailing wisdom of other
investors, shorting gold certainly fits the bill. Right now, everyone
else is buying gold, or at least recommending it. If you have any
doubt we’ve reached such fever pitch levels, consider No. 2.

The infomercial factor. The best indicator of a turning point for any
investment, in my experience, is infomercials. If an investment gets
so popular it invades the pre-dawn hours with non-stop but-wait-
there’s-more offers, it’s time to get out. And that’s exactly what’s
happening now. So much so companies like Cash4Gold.com are invading
primetime television. They even splurged for a Super Bowl ad spot. And
they recruited washed-up celebrities Ed McMahon and M.C. Hammer to
boot. In case you forgot, the Hammer filed bankruptcy in 1996. And
Eddie boy almost lost his 7,000 square-foot, $6.5 million Beverly
Hills pad to foreclosure. No offense, if you take investment cues from
these two, you deserve to lose money.

There is always some truth in a rumor. Recent news reports suggested
Germany, the world’s second-largest holder of gold, was selling some
from its vaults to trim its deficit. It turned out to be a rumor. But
you gotta wonder if there’s some truth behind it. After all, high gold
prices would be an easy way to raise cash. In other words, the
scenario is completely plausible. And if Germany’s considering it,
even remotely, so, too, are plenty of other deficit-ridden
governments. It goes without saying that a government dumping supply
on the market will send prices lower, quickly.

The gold-to-oil ratio is out of whack. Historically, an ounce of gold
will buy you about 14 barrels of oil. But with oil around $40 per
barrel, an ounce of gold gets you almost 23 barrels – a whopping 64%
above the historical mean. If you believe in statistics, a reversion
to the mean is imminent!

So is the gold-to-silver ratio. Historically, an ounce of gold will
buy you 31 ounces of silver. But now the ratio stands at 73 – an
unbelievable 134% above the historical mean. Here, too, a reversion to
the mean is imminent. And I’d rather place my bets on a 57% decrease
in the price of gold, than silver more than doubling to make it
happen.

The HGNSI index is too high at 60.9%. For the past 25 years, Hulbert
Financial Digest has tracked the average recommended gold market
exposure among a subset of gold-timing newsletters. It usually fleshes
out around 32.6%. But now it rests at 60.9%, a level it’s only
exceeded 13% of the time. The key – Hulbert found an inverse
correlation exists between his proprietary index and the short-term
market direction of gold. In other words, if the index is high, like
now, gold is headed lower.

Trinkets drive demand, not governments or speculators. Nearly 75% of
gold demand comes from the jewelry market. And if Indian brides balk
at buying above $750 per ounce as the Bombay Bullion Association
reports – India’s gold imports cratered 81% in December – look out
below. And don’t be fooled into thinking investors (governments or
speculators) will pick up the slack. As HSBC reports, rising demand
from investors, particularly from ETFs, only offset half of the 33%
decline in jewelry market demand since 2001.

What makes now “different?” If the global economic crisis keeps
getting worse, as goldbugs like to point out, why hasn’t gold tested
last March’s high of $1,030.80 per ounce? Or blown right by it? After
all, gold is supposed to increase in value as economic conditions
worsen. But it hasn’t lived up to expectations, not one bit. And I
don’t think it ever will. Ultimately, when you factor in the massive
amounts of stimulus being injected into the markets, on a global
level, we’re close to the worst of times… and the peak for gold.

Analysts love it. According to Bloomberg, 16 of 24 analysts surveyed
by the London Bullion Market Association believe gold will reach a
minimum of $1,032 per ounce this year. As we all know, analysts’ track
records are deplorable. Instead of just ignoring them, why not bet
against them? The odds are definitely in our favor.

Hedge fund buying dried up. Institutional speculators (hedge funds)
played a large part in gold’s run-up. But 920 of them went Kaplooey
last year, according to Hedge Fund Research, Inc. Not to mention,
hundreds of others hemorrhaged capital as investors demanded their
money back, while those left standing ratcheted down borrowing to
close to nothing, according to Rasini & C., a London-based investment
adviser. In the end, gold prices will eventually reflect the absence
of these former heavyweights.

Gold is schizophrenic and the wrong personality is in control.
Multiple motivations exist to buy gold including the desire for a safe
haven, currency, adornment, raw material, or inflation hedge. But much
like Treasuries, the bulk of buyers come from the safe haven camp
today. And once the economy shows any signs of perking up, we can
expect these same investors to flee for more risky assets. And don’t
be so quick to rule out a second half recovery…

The Fed, the President, history and the Baltic Dry Index concur – the
economy’s on the mend. Despite dismal data, both the Fed and President
Obama point to the current recession ending by the second half of
2009. Moreover, the average recession only lasts 14.4 months. So even
if this one is longer than usual, we’re still near the tail end of it.
A fact underscored by the recent 61.4% rally in the Baltic Dry Index
from its early December low. As I wrote in November 2008, the index is
the first pure indicator of an uptick in global activity. And once the
economy gets back into gear, the Fed will act quickly to reign in the
money supply and curb inflation.
Cleary the gold rush is on. But that’s all the more reason to move in
the opposite direction, against the herd. I realize this might be the
most unpopular recommendation right now, but that means it could also
be the most profitable.

And before you brandish me a fool for recommending shorting Treasuries
and gold in the span of two months, here’s the intersection. The
driving force behind both assets in recent months has been safe haven
buying. And it will remain the dominant variable in determining price
in the months ahead. So when investors go back on the attack for more
risky assets, prices for both assets will fall.

It’s already happening for Treasuries. And I’m convinced gold is next.

Good (and contrarian) investing,

by Louis Basenese, Advisory Panelist
Senior Analyst, The Oxford Club

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