Has Gold Had It?

With the Federal Reserve signaling yesterday that QE3 is off the table, many traders are now betting that the barbarous relic is about to take a prolonged vacation.

Without a dividend or an interest yield in a world desperate for cash flow, the yellow metal suddenly doesn’t have so much to offer. Take away the fear of inflation that our deflationary reality assures, and gold is suddenly left wanting, along with all other hard assets. Uncle Buck becomes the big man on campus.

For the first time in many years, gold is ranking high on the list of preferred hedge fund shorts. The US Treasury’s sale of America eagle one ounce gold coins is down 70% from last year and is now plumbing a four year low. Open interest in the gold futures market has hit a 2 ½ year low, indicating that capital is fleeing the market. This is usually what happens before prices die.

Physical markets in Asia, long a bulwark in the gold bull case, are suffering from declining volumes. India, long the world’s largest buyer of physical gold, just doubled import taxes, causing widespread strikes among jewelers.

Industry experts have been warning me for some time that the scrapage rate was soaring, thanks to retail gold buying shops popping up on almost every other street corner, and it was just a matter of time before this would have a major dampening effect on prices.  Remember those stories about gold coin vending machines popping up around the world? You don’t hear those anymore.

Indeed, the gold miners have been signaling for some time that the gold bugs were about to suffer a healthy dose of insecticide. Look no further than the chart for Barrack Gold (ABX), the world largest producer of the yellow metal, and a woeful underperformer compared to its benchmark product. Other miners have fared far worse.

Take speculation about future gold price appreciation away, and all of a sudden miners don’t have such a great business model. The problem is that they are not making gold anymore. Companies are having to dig deeper in more dangerous and inaccessible parts of the world, and pay bigger bribes to get there. (ABX) isn’t opening a new mines at 15,000 feet in the Andes because their like the fresh air and the scenery. Freezing water, and essential ingredient in the mining process, has become a major problem.

There is the added dilemma that the inventory sitting in the back of the shop is now falling in value instead of increasing. Barrack has made a big deal about abandoning its gold hedging strategy. That worked great for the past three years, but may not do as well going forward.

Cost inflation suffered by mining companies is the highest in the industrial world, and is now running at about a 20% annual rate, be it for labor, heavy equipment, infrastructure development, royalty fees, and so on. The tires for those giant trucks used in mining now cost $100,000 each and have a three year waiting list. The secondary market for them is booming.

It doesn’t take a rocket scientist to figure out that the technical picture for gold has been rapidly deteriorating. Gold has suffered an 8% sell off since the end of February, and is now up only 6% in 2012, underperforming most other asset classes. Look at the chart below, and the most charitable thing you can say is that with are approaching the bottom end of a $1,500-$1,925 range. But look at the longer term charts and it is clear that we have just witnessed a head and shoulders formation that has dramatically failed.

The chip shot on the downside for gold here is $1,500. More aggressive traders may want to reach for $1,450. Bring a double dip scare for the economy into the picture, which I expect to see this summer, and $1,100 is a possibility. If you get a real stock market crash in 2013, as many analysts are predicting, and you’ll get another chance to buy at $750.

Use the periodic short term bursts of buying, that are increasingly being seen by the trading community as a contrarian trade, as a great chance to leg into short dated puts on the SPDR Gold Trust Shares ETF (GLD).

Long term, I still like gold and expect it to hit the old inflation adjusted high of $2,300 during the next hard asset buying binge. But remember also that long term, we are all dead.




Watch Out for Gold’s Fatal Attraction