Back on May 15, in Gold to Rise Before a Fall
, I mentioned that although I was bearish a longer term basis, I felt gold would undergo an important transition that was constructive in the short term. I predicted that gold would move from being traded as a flight to safety play to being traded as a “reflation” play in the context of positive global growth surprises. It was my view at that time that the prospect for a global economic recovery would stoke some concerns about inflation.
Nonetheless, I was clear in stating that I would not be playing gold. First, I was very clear that the eternal expectation by gold bugs that inflation would reignite in the short or medium term was dead wrong. Secondly, I predicted that gold would be a vastly inferior reflation vehicle relative to other commodities.
These predictions have proven to be quite prescient. First, gold did recover as a “reflation” play in line with a surge in optimism regarding global growth, heightened concerns regarding future inflation and worries about the lack of clear “exit policies” of global central banks. Second, gold did indeed underperform relative to other commodities. Finally, inflation has continued to decelerate.
So what is my view on gold at the present time?
In the short term, I see a variety of headwinds for gold. And in the medium term, I see an extremely bearish scenario. Here, I will focus on factors that I think will be operative in the shorter term. 1. Reflation play is fast losing its luster.
Notwithstanding simplistic monetarist dogmas to the contrary, inflation is not coming back any time soon. And the market is slowly coming to terms with that fact. Evidence of disinflation abounds, whether one looks at consumer prices or asset prices. Despite the surge in the monetary base, broad money is not accelerating at a significant rate and credit is contracting. And excess capacity in virtually all areas of the economy virtually guarantees that inflation will be kept in check. Thus, even if the good news on the economy continues for a while, I do not expect this to provide any impetus for the sort of serious inflation fears that could propel gold.2. Recovery Disappointment.
Diminished expectations of a recovery will essentially take the rug out from under the reflation thesis. As I detailed in Solving the Consumer Demand Dilemma
, it is my belief that expectations of a potential V-shaped recovery are likely to be substituted in the medium term for fears of an aborted recovery. This will be accompanied by fears of deflation. Inflation will cease to be a concern. Mish Shedlock’s Why Deflation Will Take the Wind Out of Economic Recovery
dovetails well with my own views on the subject. 3. Dollar to rally.
As I predicted in my article, 9 Post-Earnings Season Predictions
, the US dollar is likely to experience a major rally over the course of the next year or so. As I have explained in several of my articles, the US Dollar is the most fundamentally sound of all of the major currencies in the world, and this basic fact will become increasingly evident in the next 12 months as problems in Europe and Asia begin to deepen. Technically a bottom in the dollar seems to be lining up with the transition in the above-mentioned fundamentals. Although I am not a follower of Elliot Wave Theory I would note that Robert Prechter has come out recently predicting a major bottom for the dollar based on his wave theory.
Aside from the wave count, he has also cited the incredible statistic that the Dollar Sentiment Index is registering only 3% bulls, one of the lowest readings in 20 years. Note that in March of 2008 when the dollar bottomed, the Dollar Sentiment Index registered 5% bulls. This compares to a reading of 93% bulls in March of 2009 when the dollar topped.
Thus, technical and fundamental factors are converging in favor of the US Dollar. Gold will slump in response to a rising dollar for 2 reasons: The first is that the US dollar collapse thesis has been a major underpinning for gold and this thesis will become thoroughly discredited. The second is that a rising dollar means that gold becomes more expensive in the rest of the world and the vast majority of the world’s demand for gold is outside of the US.
Longer term, I am even more bearish on gold for reasons I plan to expand upon at a later time. However, for now, I am going to initiate a relatively modest short position as I am not entirely certain on the timing. I would ordinarily have liked to short gold nearer the $1,000 threshold. And I do not necessarily see a micro-term bearish catalyst.
I simply think it is time to start averaging in on a short gold position. This can be done by shorting GLD
, or going long DZZ
which is a double inverse gold ETF.
Using GLD, I would probably short it again at around $96 and then all the way up to $100. A stop could be placed a few dollars above that level. On the downside, a violation of $89 and then $85 would warrant increasingly aggressive shorts as it would signal a potential major breakdown in the yellow metal.
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