Although I have been inaccurately referred to as a “gold hater” as a result of my recent views on the medium-term prospects for the yellow metal, the fact is that I have been an active gold investor for over 20 years. In fact, in February, I took profits on a very sizable gold stock position in companies such as Gold Miners ETF (GDX), Compania de Minas Buenaventura (BVN), Yamana (AUY), Comex Gold (IAG), Eldorado Gold (EGO), Centerra (CAGDF) and Peter Hambro (POGNY). 

In March, in a Buzz entitled “The Gold Trade Conundrum,” I laid out an outline of a rationale as to why I felt gold was unlikely to make much headway over the medium term and why I would not, for the time being, be re-entering the gold / gold stock trade on the pullback occurring at that time (despite having previously thought that I might). I still feel that this rationale applies today. In that piece, I hypothesized that the gold trade was about to undergo a transition. I believe that this transition has been in evidence since that time.

The intense fear of an economic apocalypse that had clearly been driving gold for several months has given way, and the partial relief of psychic tensions has consequently triggered a correction in the yellow metal. However, ironically, the emergence of the possibility of an economic resurgence has also led to questions about whether inflationary pressures might be triggered.

Thus, gold is moving from being traded as “safe haven” play and is gaining a bit of traction as a “reflation play.” Notwithstanding, it is important to note that even within the context of the broader reflation play, gold and gold stocks have badly underperformed other commodities and commodity stocks.

I do not think gold will rally very far based on concerns about inflation. The reason is simple: The arguments offered by gold bugs for hyperinflation or high inflation, are empirically and even theoretically unsound. There is minimal risk of significant inflation occurring any time within an investment horizon that can be considered to be highly relevant to the market (1-2 years). Thus, as the data roll in, and this reality sinks in, gold will lose its appeal as a supposed inflation hedge.

The other reason gold is unlikely to be a stellar performer is of a technical nature: The simplistic arguments that posit inevitable inflation from an increases in the monetary base are so hackneyed and over publicized that just about anybody that believes in these scenarios has already invested. Thus, at $900-$1,000, the risk of high inflation or even hyperinflation is already well factored into the price of gold.

In the short term, I would expect that the “reflation trade” associated with increased optimism about the prospects for an economic recovery could propel gold towards its recent highs. Endless, and usually unsound, speculation about the Fed’s monetary policy should also play into this “reflation” narrative.

In addition, and somewhat ironically, periodic bouts of bad economic or financial news will tend to bring back some “safe haven” buying. Any apparent contradiction within these crosscurrents will be “resolved” by gold bugs by invoking the specter of stagflation. All of these are potential sources of support that could propel gold towards its recent highs.

For now, given my belief that economic data in the next couple of months will tend to be surprisingly positive, it seems to me that gold could be headed modestly higher on a short-term basis as a reflation play. However, at some point, as apocalyptic and hyperinflationary scenarios lose credibility, and as investors begin to focus on serious fundamental and technical vulnerabilities in the global market for gold, the yellow metal might become a very interesting short. I will be writing on this more in the future as developments warrant.