Best of the Week

Gold Fundamentals Are Being Ignored

Commodities / Gold & Silver Mar 30, 2008 - 07:38 PM

Best Financial Markets Analysis Article Almost every article on gold seems to be stating that the yellow metal is being bought up due to these troubled economic times. If I hear the words “safe haven” again, I'm going to be sick. In other words, it is proposed that investors will lose confidence in the value of the dollar and revert back to the olden days of bartering in physical goods. Analysts are throwing around ridiculous forecasts for gold of $2,000, $5,000, even $100,000 per troy ounce.

This is balderdash. Gold is a commodity that is priced based on supply and demand factors like any other commodity. You could just as easily put your life savings into pork bellies. The buying power of the almighty dollar has been recently very stable, losing about 2 to 3 percent per year, which can be made up simply by investing in treasuries without having to store gold in your basement. Bernanke may be helicoptering billions of dollars to bail out investment firms, but the Federal Reserve is still keeping their eye on inflation. No, investors are not buying gold as a safe haven, they're buying gold to profit. Be careful. He who lives by the sword can easily die by the sword.

Supply

The gold supply side is not like oil. There is enough gold to last thousands of years. There is no cartel that metes gold to the markets to maintain prices. Gold generally doesn't get used up, it sits around waiting to be resold. As prices increase, more and more gold mines become economically viable. There is more motivation to take your unused jewelry to the pawn shop. Ten-carat gold starts to look as shiny as eighteen-carat gold. The IMF is eyeing their gold stores as a potential source of revenue to finance their operations. All these factors will add to the gold supply.

Demand

India , the world's largest gold consumer has curtailed their gold imports by over 60% in the last two quarters. Flat-screen televisions are replacing gold at weddings. Jewelry is being recycled at record rates. The world has not found any new radical industrial uses for gold, so this demand is stable. By far the greatest change in gold demand has been from hoarding. Street Tracks gold ETF has increased its inventories by a whopping 600 tonnes in three years. This has dramatically tightened the gold fundamentals and is the main cause for the current run-up in gold prices. The most amazing thing is that gold prices have only increased by 50% over this time, thereby showing the underlying weakness in this commodity. Try removing one quarter of the world's production of live cattle – beef prices would triple.

Gold demand is also inversely affected by price volatility. Volatility is the enemy of investors. Volatility means risk. As volatility increases, the less I have to buy to realize my profit objective. The volatility of gold prices has increased three-fold in the last year. This means I can buy one third the amount of gold to realize my profit objective or meet my stop-loss.

If gold prices start to fall, hoarding can very quickly reverse course. In this case the hoarders will be forced to plough back their holdings into a grumpy market when traders aren't exactly in the buying mood.

Gold bugs will start to get hurt this year or next. They'll stand resolutely by as the price drops to $900, $800, $700. However, eventually they'll come to the realization that they won't make their fortune this time and will be forced to sell, either by their broker's margin calls, or by their wife. Then the bottom will drop out on gold prices. There will be no safety net. Unlike with the stock market or house prices, the federal treasury will cheer mercilessly when gold prices start to plummet.

Comex Gold December 2009 puts are trading cheap at $620. There is a fortune to be made.

By John Handbury
http:// www.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

John Handbury Archive

Comments

Pejvan
03 Apr 08, 15:35

fundamentally wrong on Gold

Hi,

I often read your articles with great interest, but this one far more than disappointed me as far as the logic of it seem to be wrong, before even trying to see if your supply and demand lists are correct.

When you say "The gold supply side is not like oil. There is enough gold to last thousands of years." what exactly do you mean? That people who are being oil for the current months are making reserves for when oil the oil reserves are vanished? There are according to surveys (how reliable are they??) about 40 years of proven reserves. The cost of brigning oil that oil to the surface hasn't changed enormously to justify that the price moves from 25$ a baril 3-4 years ago to 110$. So if oil can rise by 400%, why couldn't gold? we are not lacking oil, even on the short term: reserves are increasing in the US (and haven't seen any gas or petrol station closed due to lack of oil so far :-) )

Then there is the incredible sentence that made pull my hair: "The buying power of the almighty dollar has been recently very stable, losing about 2 to 3 percent per year, which can be made up simply by investing in treasuries without having to store gold in your basement." Who can believe that real inflation is only 2-3%? specially when M3 and MZM have been growing by as much as 50% in the past 5 years? Core-CPI is the most biased measure of inflation, and even this one has been steadily showing an inflation of more than 2-3% annualized!!!

Then, well, there are so many basic and simplistic assumptions on your text than the only thing I can recommend is that you get more familiar with what the Fed actually is, what the real figure about inflation and money supply are, and also get a couple of books about gold as inflation hedging.

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