Gold has become the ugly duckling during this bull market for stocks and bonds. However, that is not going to last.
Gold will eventually come back in fashion and when it does, how high could it really go?
The question begs your rapt attention as the possibility of Britain leaving the EC has suddenly unleashed a plethora of new positive fundamentals for the yellow metal.
It turns out that gold is THE deflationary asset to own. Who knew?
I was an unmitigated bear on the price of gold after it peaked in 2011. In recent years, the world has been obsessed with yields, chasing them down to historic levels across all asset classes.
But now that much of the world already has or is about to have negative interest rates, a bizarre new kind of mathematics applies to gold ownership.
Gold’s problem used to be that it yielded absolutely nothing, cost you money to store, and carried hefty transactions costs. That asset class didn’t fit anywhere in a yield-obsessed universe.
Now we have a horse of a different color.
Europeans wishing to put money in a bank have to pay for the privilege to do so. Place €1 million on deposit on an overnight account, and you will have only 996,000 Euros in a year. You just lost 40 basis points on your -0.40% negative interest rate.
With gold, you still earn zero, an extravagant return in this upside down world. All of a sudden, zero is a win.
For the first time in human history, that gives you a 40 basis point yield advantage over Euros. Similar numbers now apply to Japanese yen deposits as well.
As a result, the numbers are so compelling that it has sparked a new gold fever among hedge funds and European and Japanese individuals alike.
Websites purveying investment grade coins and bars crashed multiple times last week, due to overwhelming demand (I occasionally have the same problem). Some retailers have run out of stock.
And last week, the fever went pandemic as silver rocketed 14.28%, and others like Platinum (PPLT) and Palladium (PALL) were also frenetically bid.
So I’ll take this opportunity to review a short history of the gold market (GLD) for the young and the uninformed.
Since it peaked in the summer of 2011, the barbarous relic was beaten like the proverbial red-headed stepchild, dragging silver (SLV) down with it. It faced a perfect storm.
Gold was traditionally sought after as an inflation hedge. But with economic growth weak, wages stagnant, and much work still being outsourced abroad, deflation became rampant.
The biggest buyers of gold in the world, the Indians, have seen their purchasing power drop by half, thanks to the collapse of the rupee against the US dollar. The government increased taxes on gold in order to staunch precious capital outflows.
You could also blame the China slowdown for declining interest in the yellow metal which is now in its fifth year of falling economic growth.
Chart gold against the Shanghai index and the similarity is striking until negative interest rates became widespread in 2016.
The brief bid gold caught in 2015 over war fears in Syria, Ukraine, and then Iraq was worth an impressive $160 rise.
That is when the diplomats got involved and hostilities were at least delayed causing gold to roll over like the Bismarck.
In the meantime, the gold supply/demand balance was changing dramatically.
While no one was looking, the average price of gold production soared from $5 in 1920 to $1,300 today. Over the last 100 years, the price of producing gold has risen four times faster than the underlying metal.
It’s almost as if the gold mining industry is the only one in the world which sees real inflation since costs soared at a 15% annual rate for the past five years.
This is a function of what I call “peak gold.” They’re not making it anymore. Miners are increasingly being driven to higher risk, more expensive parts of the world to find the stuff.
You know those tires on heavy dump trucks? They now cost $200,000 each, and buyers face a three-year waiting list to buy one.
Barrack Gold (ABX) didn’t try to mine gold at 15,000 feet in the Andes, where freezing water is a major problem, because they like the fresh air.
What this means is that when the spot price of gold fell below the cost of production, miners will simply shout down their most marginal facilities, drying up supply. That has recently been happening on a large scale.
Barrick Gold, a client of the Mad Hedge Fund Trader, can still operate as older mines carry costs that go all the way down to $600 an ounce.
No one is going to want to supply the sparkly stuff at a loss. That should prevent gold from falling dramatically.
I am constantly barraged with emails from gold bugs whom passionately argue that their beloved metal is trading at a tiny fraction of its true value and that the barbaric relic is really worth $5,000, $10,000, or even $50,000 an ounce (GLD).
They claim the move in the yellow metal we are seeing now is only the beginning of a 30-fold rise in prices similar to what we saw from 1972 to 1979 when it leaped from $32 to $950.
So when the chart below popped up in my inbox showing the gold backing of the US monetary base, I felt obligated to pass it on to you to illustrate one of the intellectual arguments these people are using.
To match the gain seen since the 1936 monetary value peak of $35 an ounce, when the money supply was collapsing during the Great Depression, and the double top in 1979 when gold futures first tickled $950, this precious metal has to increase in value by 800% from the recent $1,050 low. That would take our barbarous relic friend up to $8,400 an ounce.
To match the move from the $35/ounce, 1972 low to the $950/ounce, 1979 top in absolute dollar terms, we need to see another 27.14 times move to $28,497/ounce.
Have I gotten you interested yet?
I am long term bullish on gold, other precious metals, and virtually all commodities for that matter. But I am not that bullish. These figures make my own $2,300/ounce long-term prediction positively wimp-like by comparison.
The seven-year spike up in prices we saw in the seventies, which found me in a very long line in Johannesburg, South Africa to unload my own krugerands in 1979, was triggered by a number of one-off events that will never be repeated.
Some 40 years of unrequited demand was unleashed when Richard Nixon took the US off the gold standard and decriminalized private ownership in 1972. Inflation then peaked around 20%. Newly enriched sellers of oil had a strong historical affinity with gold.
South Africa, the world’s largest gold producer, was then a boycotted international pariah and teetering on the edge of disaster. We are nowhere near the same geopolitical neighborhood today, and hence, my more subdued forecast.
But then again, I could be wrong.
In the end, gold may have to wait for a return of inflation to resume its push to new highs. The previous bear market in gold lasted 18 years, from 1980 to 1998, so don’t hold your breath.
What should we look for? The surprise that your friends get out of the blue pay increase, the largest component of the inflation calculation.
This is happening now in technology, but nowhere else. When I visit open houses in my neighborhood in San Francisco, half the visitors are thirtysomethings wearing hoodies offering to pay cash.
It could be a long wait for real inflation, possibly into the mid-2020s, when shocking wage hikes spread elsewhere.
You may have noticed that I have been playing gold from the long side virtually every month since it bottomed in January. I’ll be back in there again given a good low risk, high return entry point.
You’ll be the first to know when that happens.
As for the many investment advisor readers who have stayed long gold all along to hedge their clients' other risk assets, good for you.
You’re finally learning!
https://www.madhedgefundtrader.com/wp-content/uploads/2014/07/John-Thomas-Gold-e1455831491219.jpg297400Mad Hedge Fund Traderhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2019-05-08 01:07:542019-05-07 21:01:47The Ultra Bull Argument for Gold
Global Market Comments September 27, 2018 Fiat Lux
Featured Trade: (HOW TO GAIN AN ADVANTAGE WITH PARALLEL TRADING), (GM), (F), (TM), (NSANY), (DDAIF), BMW (BMWYY), (VWAPY), (PALL), (GS), (RSX), (EZA), (CAT), (CMI), (KMTUY), (KODK), (SLV), (AAPL), (TUESDAY, OCTOBER 16, 2018, MIAMI, FL, GLOBAL STRATEGY LUNCHEON)
One of the most fascinating things I learned when I first joined the equity trading desk at Morgan Stanley during the early 1980s was how to parallel trade.
A customer order would come in to buy a million shares of General Motors (GM) and what did the in-house proprietary trading book do immediately?
It loaded the boat with the shares of Ford Motors (F).
When I asked about this tactic, I was taken away to a quiet corner of the office and read the riot act.
“This is how you legally front run a customer,” I was told.
Buy (GM) in front of a customer order, and you will find yourself in Sing Sing shortly.
Ford (F), Toyota (TM), Nissan (NSANY), Daimler Benz (DDAIF), BMW (BMWYY), or Volkswagen (VWAPY), are no problem.
The logic here was very simple.
Perhaps the client completed an exhaustive piece of research concluding that (GM) earnings were about to rise.
Or maybe a client old boy network picked up some valuable insider information.
(GM) doesn’t do business in isolation. It has tens of thousands of parts suppliers for a start. While whatever is good for (GM) is good for America, it is GREAT for the auto industry.
So through buying (F) on the back of a (GM) might not only match the (GM) share performance, it might even exceed it.
This is known as a Primary Parallel Trade.
This understanding led me on a lifelong quest to understand Cross Asset Class Correlations, which continues to this day.
Whenever you buy one thing, you buy another related thing as well, which might do considerably better.
I eventually made friends with a senior trader at Salomon Brothers while they were attempting to recruit me to run their Japanese desk.
I asked if this kind of legal front running happened on their desk.
“Absolutely,” he responded. But he then took Cross Asset Class Correlations to a whole new level for me.
Not only did Salomon’s buy (F) in that situation, they also bought palladium (PALL).
I was puzzled. Why palladium?
Because palladium is the principal metal used in catalytic converters, which remove toxic emissions from car exhaust, and have been required for every U.S. manufactured car since 1975.
Lots of car sales, which the (GM) buying implied, ALSO meant lots of palladium buying.
And here’s the sweetener.
Palladium trading is relatively illiquid.
So, if you catch a surge in the price of this white metal, you would earn a multiple of what you would make on your parallel (F) trade.
This is known in the trade as a Secondary Parallel Trade.
A few months later, Morgan Stanley sent me to an investment conference to represent the firm.
I was having lunch with a trader at Goldman Sachs (GS) who would later become a famous hedge fund manager and asked him about the (GM)-(F)-(PALL) trade.
He said I would be an IDIOT not to take advantage of such correlations. Then he one-upped me.
You can do a Tertiary Parallel Trade here through buying mining equipment companies such as Caterpillar (CAT), Cummins (CMI), and Komatsu (KMTUY).
Since this guy was one of the smartest traders I ever ran into, I asked him if there was such a thing as a QuaternaryParallel Trade.
He answered “Abso******lutely,” as was his way.
But the first thing he always did when searching for Quaternary Parallel Trades would be to buy the country ETF for the world’s largest supplier of the commodity in question.
In the case of palladium, that would be Russia (RSX) followed by South Africa (EZA), which together account for 74% of the world’s total production.
Since then, I have discovered hundreds of what I can Parallel Trading Chains, and have been actively making money off of them. So have you, you just haven’t realized it yet.
I could go on and on.
Do this for decades as I have and you learn that some parallel trades break down and die. The cross relationships no longer function.
The best example I can think of is the photography/silver connection. When the photography business was booming, silver prices rose smartly.
Digital photography wiped out this trade, and silver-based film development is still only used by a handful of professionals and hobbyists.
Oh, and Eastman Kodak (KODK) went bankrupt in 2012.
However, it seems that whenever one Parallel Trading Chain disappears, many more replace it.
You could build chains a mile long simply based on how well Apple (AAPL) is doing.
Suffice it to say that parallel trading is an incredibly useful trading strategy.
Ignore it at your peril.
It’s a Long and Winding Road to Get Here
https://www.madhedgefundtrader.com/wp-content/uploads/2018/09/Palladium-image-5-e1537994439519.jpg267400MHFTRhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMHFTR2018-09-27 01:07:392018-10-04 13:06:47How to Gain an Advantage with Parallel Trading
The market has been chattering quite a lot about the massive downside bets on the S&P 500 being placed by some of the industry?s best known players.
That is something I would expect from my long time client and mentor George Soros.
But Warren Buffett as well? He is one of the greatest long term, pro America bulls out there.
It is the sort of news that gives investors that queasy, seasick feeling in the pit of their stomachs. You know, like when a new Tesla owner shows off his warp speed ?ludicrous mode??
That is unless you are running heavy short positions in stocks, as I am.
Every technical analyst in the world is pouring over their charts and coming to the same conclusion. A ?Head and Shoulders? pattern is setting up for the major indexes, especially for the S&P 500 (SPY).
And if you think the (SPY) chart is bad, those for the NASDAQ (QQQ), and the Russell 2000 (IWM), look much worse.
This is terrible news for stock investors, as well as owners of other risk assets like commodities, oil and real estate. It is wonderful news for those long of Treasury bonds (TLT), the Euro (FXE), gold (GLD), and silver (SLV).
A head and shoulders pattern is one of the most negative textbook indicators out there for financial markets. It means that there is only enough cash coming in to take prices up to the left shoulder, but no higher.
There is not even enough to challenge the old high, taking a double top decidedly off the table.
The bottom line: the market has run out of buyers. Be very careful of markets where everyone is bullish long term, but no one is doing any buying.
When the hot, fast money players see momentum rapidly fading, they pick up their marbles and go home. Some of the most aggressive, like me, even flip to the short side and make money in the falling market.
If we make it down to the ?neckline? and it doesn?t hold, then the sushi really hits the fan. Right now, that neckline is at $204.60 in the S&P 500 (SPY). Break that, and it?s hasta la vista baby. See you later.
Stop losses get triggered, the machines takeover, and shares move to the downside with a turbocharger. Distress margin calls on the most levered players (usually the youngest ones) add further fuel to the fire. We might even get a flash crash
This is when the really big money is made on the short side.
There is a new wrinkle this year that could make this sell off particularly vicious. To see a formation like this setting up during May is particularly ominous. It means that ?Sell in May? is going to work one more time
?It?s not like we have any shortage of bearish headlines to prompt a stampede by the bears.
The turmoil in Europe, one of the largest buyers of American exports, could cause the US to catch a cold. This is what the latest round of earnings disappointments has been hinting at.
Margin debt to own stocks has recently exploded to an all time high.
It could well be that the market action is just the dress rehearsal for a deeper correction in the summer, when markets are supposed to go down.
If markets do breakdown, it won?t be bombs away. The (SPY) might make it down to $181, $177, or in an extreme case $174. But to get sustainably below that, we really need to see an actual recession, not just a growth scare.
Remember that earnings are still growing year on year, once you take out the oil industry. That is not a formula for any kind of recession.
It is a formula for a 10% sell off in an aged bull market. That?s where you load the boat with the best quality stocks (MSFT), (FB), (GOOG), (CELG), etc., which should be down 25-35%, and then clock your +25% year in your equity trading portfolio.
If you are NOT a trader, but a long-term investor monitoring you retirement funds, just go take a round-the-world cruise and wake me up on December 31. You should be up 5% or more, with dividends, and skip the volatility.
Ignore It at Your Peril
Volatility? What Volatility?
https://www.madhedgefundtrader.com/wp-content/uploads/2014/04/Head-Shoulders-Shampoo.jpg363189Mad Hedge Fund Traderhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2016-05-18 01:08:012016-05-18 01:08:01Watch Out for the Head and Shoulders