by Ivan Martchev | April 29, 2013 6:30 am
Goldbugs like to think that every time gold has a big rally, central bankers of the world cringe … and that every time it has a big selloff, they celebrate. This is because central banks aim to manufacture credit growth, which at its base starts with the creation of fiat, or paper, money.
In goldbugs’ eyes, central bankers are their enemy, and inflation is their friend.
The recent selloff in gold is seven standard deviations away from a 20-year mean distribution, making the move either some sort of a selling climax or the beginning of a much larger decline.
Here is why I think it is the latter, after the mandatory dead-cat bounce fizzles out:
What has been troubling me for months — and still true today — is the massive under-performance of gold mining shares relative to the price of gold bullion.
The theory says that as the price of gold bullion rises, gold mining shares should outperform as their operating margins would expand if their operating costs do not rise as fast. I was aghast when I found the recent estimate by a major reputable broker like Nomura placing global gold mining costs at $1,200 per ounce. Mining costs have tripled and quadrupled with the price of gold bullion and in many cases have risen (much) faster. The industry as a whole has languished as the price of gold has risen.
The breakdown of relative performance of larger-cap gold mining stocks (as represented by the GDX-GLD ratio) had begun before gold hit an all-time high in September 2011. This relative breakdown had gotten quite a bit worse, with the GDX:GLD ratio making a new low way before the the big 7-sigma selloff in gold bullion in April that made so many headlines. For the followers of gold mining shares, it had already been a serious bear market for quite some time. The same is true for the relative performance of small-cap gold mining shares relative to larger-cap ones (as represented by GDXJ:GDX), as well as silver miners relative to silver bullion.
This price action reminds me of 2008, when we had similar relative underperformance of gold mining shares vs. new highs for gold bullion, which got much worse as the year dragged on, completely collapsing toward the end of 2008 with the failure of Lehman Brothers. I do not consider myself a “chart guy,” but I have been following the precious metals sector for a long time, and this trading pattern and how mining stocks and bullion are reacting to news and other financial market developments feels eerily similar.
This is undoubtedly a different environment than 2008, yet there are some striking similarities, too.
The dollar has a firm bid due to serious issues with the yen and the euro. The decline in the yen is manufactured to help fight rampant deflation in the country, which has crippled the economy and the banking system, while the decline in the euro is overdue given the inability of the Europeans to get out of their spectacular multidimensional political and economic mess.
So the dollar index — which is 57.6% weighted toward euros and 13.6% weighted toward yen — is going up, not because the situation in the U.S. is rosy, but because the situation in Europe and Japan is much, much worse. Even though the Fed is printing and the U.S. Treasury is minting and piling on debt obligations of the U.S. federal government, gold prices might go even lower, while anti-gold — a.k.a. the U.S. dollar — keeps going higher.
Purchasing power parities for the yen and the euro still show that both currencies are overvalued. Depending on which PPP one uses — there is the GDP, private consumption and other kinds — the yen can go as low as 120 to the dollar from the present level around 100 and the euro to 1.11.
Still, in currency dislocations brought on by financial crises, currencies rarely stay near PPP levels and tend to grossly overshoot. The yen went as low as 145 in the Asian Crisis, and the euro traded to 82 U.S. cents after introduction. It is conceivable that if things in Europe deteriorate and the Japanese central bank keeps quantitative easing efforts that are more aggressive than the Fed’s relative to the size of the Japanese economy, we could see a EURUSD parity and a 120 USDJPY exchange rate in the next 12 to 18 months. In that scenario, gold bullion has further to fall.
As to how much it can fall, readers will have to ask themselves what is a “normal” decline for gold bullion in a potential 20% surge for the U.S. dollar under the above-described scenario.
The dollar has many problems — fiscal and trade deficits, unorthodox monetary policy, etc. — that will continue to plague it for years if they are not reversed in due course. But in the land of the blind, the one-eyed man is king … and this is very much true for the greenback at present.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds positions in GLD for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities.
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