Gold's "Contrarian Moment"

By David Galland, Casey Research

Glancing at the news most days, it's hard not to feel like Bill Murray's character in Groundhog Day. In the event you are unfamiliar with the movie, in it Murray's character becomes trapped in the same day… day after day.

In the current circular condition, we have the powers-that-be assuring us that the next high-level meeting will finally produce a permanent fix to the broken economy, essentially solving the sovereign debt crisis. Then, in no more than a few days, or at most a couple of weeks, the fix is revealed to be flawed and the crisis again sparks into flames... followed shortly thereafter by yet another high-level meeting – and the cycle begins anew.

While the characters may change – one week it is Greece, the next it is Spain, the next it is France, the next it is the US, the next it is Greece again, etc., etc. ad nauseam – the detached observer can only come to the conclusion that we are now well outside of the bounds of the normal business cycle.

As we at Casey Research have written on this topic at great length, I don't intend to dwell on this topic, but I did want to loop back in just long enough to comment on the recent price action in commodities, especially gold, in the face of the continuing crisis.

Today, a glance at the screen reveals that gold is trading for $1,565. For comparative purposes, as revelers warmed up their vocal cords to sing in the New Year on the last trading day of 2011, gold exchanged hands at $1,531. And exactly one year ago to the day, gold traded at $1,526 for a one-year gain of a modest 2.6%.

A year ago, the S&P 500 traded at 1,325, while today it trades at 1,318, a small loss. Yet, have you noticed we don't hear much about the imminent collapse of the US stock market, as we do about gold? This perma-bear sentiment about gold on the part of what some people lump together under the label "Wall Street" is especially apparent in the gold stocks.

Using the GDX ETF as a proxy for the sector, we see that the shares of the more substantial gold producers are off by an unpleasant 24% over the last year.With that "baseline" in place, let's turn to the current outlook for gold, and touch on some of the other commodities as well.

  • Gold. In the context of its secular bull market, and given that absolutely nothing has gotten better about the sovereign debt crisis – only worse – gold's correction is nothing to be concerned about.

    I know the technical types will point to levels such as $1,500 as important resistance points – and there's no question that if gold was to break decisively below that level that a lot of autopilot trades would kick in and put further pressure on gold.


    Yet, when you view the market through the lens of hard realities, which is to say, by focusing on the intractable mess the sovereigns have gotten the world into… in Europe, in Japan, in China and here in the US… then viewing gold at these levels as anything other than an opportunity is a mistake.


  • Gold Stocks. As far as the gold stocks are concerned, I consider today's levels to be extraordinarily compelling for anyone looking to build up a portfolio or to average down an existing portfolio.

    I say this for a number of reasons, starting with the contrarian perspective that this may now be the most unloved sector of the stock market. No one wants anything to do with gold stocks, and hasn't for some time now. As a consequence, the sellers will soon dry up, leaving almost nothing but buyers to push the sector back to the upside.


    This contrarian perspective is important because finding an honest-to-goodness opportunity to bet against the crowd is no easy thing in a world where literally thousands of competent equities analysts plop down at the desk each trading day with the sole purpose of searching for prospective investments. Many of these analysts are backed by huge firms with billions of dollars at risk in the markets, and so are armed with high-powered computational tools of the sort that was unimaginable even a few years ago. All of these analysts, armed with all their computational power, habitually scan a universe that totals about 4,000 publicly traded companies. Realistically, however, even a thin analytical screen will weed out all but perhaps 400 of those companies as being potentially suitable for investment.


    Thus, you have thousands of high-priced and well-armed securities analysts crunching pretty much the same data on a very small universe of possible investments. Given this reality, is it any surprise that securities are so tightly correlated? Which is to say, is it any surprise that these securities all trade right in line with the valuations that the analytical screens ultimately derive that they should? Which means there are really only two possible circumstances under which any of these stocks move up, or move down, by any significant degree

  1. Broad market movements. The saturated levels of analysis mean that, within a fairly tight range, all the stocks now move more or less together. Thus, with few exceptions, a big upswing or downswing in the broader market will send almost all stocks up or down together. To help make the point, I randomly pulled a chart of IBM and compared it against SPY (the S&P 500 tracking ETF) for the last year. Note the lockstep price movements:

    OK, IBM is a big company, so it will have a lower beta than many companies, but the point remains that saturated coverage of the stocks greatly reduces the odds of any one issue breaking free from the larger herd, unless there is…


  2. A surprise. All of these analysts, and all of their computerized analysis, help form a certain future price expectation for each security based on past financial metrics (earnings growth, return on equity, and so forth). Other than the broad market movement just referenced, or moves in line with a sub-sector of the larger market (e.g., if oil rises or falls, oil-sector stocks will tend to move up or down in sync), for a company to deviate in any substantial way from analyst expectations, by definition requires a "surprise" to occur.

    Of course, such a surprise can be positive, but because these companies are so closely watched, it is more likely to be negative. In the former category, a positive surprise might come in the form of an unexpectedly strong new product launch á la the iPad. In the latter, less happy category of surprise, it can be the blow-out of a big well in the Gulf of Mexico… or any one of a million other unanticipated vagaries of fate.

As investors, recognizing these fundamental realities is important because it points to where above-average market opportunities are most likely to be found (or not). And that brings us back to the whole idea of being a contrarian.

As mentioned a moment ago, "Wall Street" has never much liked the precious metals, and by extension the gold stocks. Given the length of the gold bull market – which, in our view, reflects systematic risk in all the fiat currencies, but which Wall Street views as an indication of a fatiguing trend confirmed by the underperformance of the gold stocks – traditional portfolio managers are unhesitant in giving the boot to the few gold shares that somehow made it into their portfolios against their better judgment.

If our thinking is not clouded by our own bias, then it would behoove us as good contrarians to buy these shares from the eager sellers at such unexpectedly favorable prices. By doing so, we are able to position ourselves to make a killing once the broader financial community realizes that the problems associated with fiat money, dramatically underscored by the intractable sovereign debt crisis, are only going to get worse. At that point gold is going to head for new highs and gold stocks to the moon.

That said, as we always should do, let's quickly assess whether our own bias is leading us astray in believing in gold and gold stocks when virtually the entire army of analysts won't even consider them. Some inputs:

    • Gold prices remain near historic highs – and that has a significant impact on the bottom line of the gold producers. Barrick Gold Corp. (ABX), for example, currently boasts a profit margin of over 30%, better than twice that of IBM and almost ten times that of Walmart. While ABX sells for just 1.6 times its book value, IBM sells for 10X.
    • Interest rates remain at historic lows, producing a negative real return for bond holders. Unless and until investors are able to capture a positive yield – a potential stake through the heart of gold – there is no lost-opportunity cost for holding gold. And bonds are increasingly at risk of loss should interest rates be pressured upwards, as they inevitably will be.
    • Sovereign money printing continues – because it must. In today's iteration of Groundhog Day, the Europeans are once again meeting in an attempt to fix the unfixable, but the growing consensus – because there is no other realistic option left to them – is that they will have to accelerate, not decelerate the money printing. Ditto here in the US, where a fiscal cliff is fast approaching due to the trifecta of the expiring Bush tax cuts, mandated cuts in government spending from the last debt-ceiling debacle and the new debacle soon to begin as the latest debt ceiling is approached. The problems in important economies such as China and Japan are as bad, and maybe even worse.


  • Debt at all levels remains high. With historic levels of debt, rising interest rates are a no-fly zone for governments, because should these rates go up even a little bit, the impact on the economy and on the ability of these governments to meet their obligations would be dramatic and devastating. This fundamental reality ensures a continuation of policies aimed at keeping real yields in negative territory, meaning that the monetization/currency debasement in the world's largest economies will continue apace.

    To get a sense of just how bad things are and how soon the wheels might come off, sending gold and gold stocks to the moon as governments throw all restraint in money printing to the wind to save themselves and their over-indebted economies – here's a telling excerpt and a chart from a recent article by Standard & Poor's titled The Credit Overhang: Is a $46 Trillion Perfect Storm Brewing?

Our study of corporate and bank balance sheets indicates that the bank loan and debt capital markets will need to finance an estimated $43 trillion to $46 trillion wall of corporate borrowings between 2012 and 2016 in the U.S., the eurozone, the U.K., China, and Japan (including both rated and unrated debt, and excluding securitized loans). This amount comprises outstanding debt of $30 trillion that will require refinancing (of which Standard & Poor's rates about $4 trillion), plus $13 trillion to $16 trillion in incremental commercial debt financing over the next five years that we estimate companies will need to spur growth (see table 1).

You can read the full article here. While the authors of the S&P report try to find some glimmer of hope that roughly $45 trillion in debt will be able to be sold off over the next four years – even their base case casts doubt on the availability of the "new money" shown in the chart above. Note that this is the funding they indicate is required to fund growth. Which is to say that should the money not be found, the outlook is for low to no growth for the foreseeable future.

It is also worth noting that the analysis assumes that something akin to the status quo will persist – which is very unlikely given the pressure building up behind the thin dykes keeping the world's largest economies intact. The landing of even a small black swan at this point could trigger a devastating cascade.

We have said it before, and we'll say it again: there is no way out of this mess  without acute pain to a wide swath of the citizenry in the world's most developed nations. While this pain will certainly be felt by sovereign bond holders (and already has been felt by those who owned Greek issues), it will quickly spread across the board to banks, businesses and pensioners – in time wiping out the lifetime savings of anyone who is "all in" on fiat currency units.

In this environment, gold isn't just a good idea – it's a life saver. And gold stocks are not just a golden contrarian opportunity, they are one of the few intelligent speculations available in an uncertain investment landscape. By speculation, I mean that, at these prices, they offer an understandable and reasonable risk/reward ratio. Every investment – even cash – has risk these days. With gold stocks, you at least have the opportunity to earn a serious upside for taking the risk… and the risk is much reduced by the correction over the last year or so.

Now, that said, there are some important caveats for gold stock buyers.

  • With access to capital likely to dry up, any gold-related company you own must be well cashed up. In the case of the producers, this means a lot of cash in the bank, strong positive cash flow and a manageable level of debt. (Our Casey BIG GOLD service – try it risk-free here – constantly screens the universe of larger gold stocks for just this sort of criteria, then brings the best of the best to your attention.)

    In the case of the junior explorers that we follow in our International Speculator service (you can try that service risk-free as well), the companies we like the most have to have all the cash they need to clear the next couple of major hurdles in their march towards proving value. That's because a company can have a great asset but still get crushed if it is forced to raise cash these days… and the situation will only get more pronounced when credit markets once again tighten as the global debt crisis deepens.


  • Beware of political risk. Despite the critical importance of the extractive industries to the modern economy, the industry is universally hated by politicians and regular folks everywhere. If your company – production or exploration – has significant assets in unstable or politically meddlesome jurisdictions, tread carefully. And it's important to recognize that few jurisdictions are more politically risky than the US. This doesn't mean you need to avoid all US-centric resource stocks – but rather that you need a geopolitically diversified portfolio that you keep a close eye on at all times (something we do on behalf of our paid subscribers every day).
  • Know your companies. Some large gold miners are also large base-metals miners. And at this juncture in time, personally I'm avoiding base-metals companies like a bad cold. While most base-metals companies have already been beaten down – and hard – over the last year and a half, the fundamentals remain poor. Specifically, they not only have the risk of rising production costs and political meddling, but unlike gold – where the driving fundamental is its monetary role in a world awash with fiat currency units – the base-metals miners depend on economic growth to sustain demand for their products. In a world slipping back into recession – or perhaps, in the case of Japan and China, tripping off a cliff – betting on a recovery in growth is not a bet I'd want to make just now.

While it is hard to accurately predict the timing of major developments in any one economy, let alone the global economy, there are a number of tangible clues we can follow to the conclusion that the next year will be a seminal one in terms of this crisis.

For starters, there is the next round of Greek elections on June 17, the result of which could very well be the anointment of one Alexis Tsipras as the head of state. An unrepentant über-leftist whose primary campaign plank is to tell the rest of the EU to put their austerity where the sun doesn't shine, the election of Tsipras would almost certainly trigger a run on the Greek banks, followed by a cutoff of further EU funding and Greece's exit from the EU. And once that rock starts to slide down the hill, it is very likely that Spain and Portugal will follow… after that, who knows? As I don't need to point out (but will anyway), June 17 is right around the corner, so you might want to tighten your seat belt.

A bit further out, but not very, here in the US we can look forward to the aforementioned fiscal cliff. Or, more accurately, the political theatrics around the three colliding co-factors in that cliff (the approach once more of the debt ceiling, the expiring tax cuts and mandated government spending cuts). While the outcome of the theatrics has yet to be determined, it's a safe bet that the government will extend in order to pretend while continuing to spend – and by doing so, signal in no uncertain terms that the dollar will follow all of the sovereign currency units in a competitive rush down the drain.

Bottom line: Be very cautious about industrial commodities as a whole, at least until we see signs of inflation showing up in earnest, but don't miss this opportunity to use the recent correction to fill out that corner of your portfolio dedicated to gold and gold stocks.

To get more perspectives like this, plus sector-specific commentary in energy, technology, and precious metals, sign up for the free Casey Research daily newsletter, the Casey Daily Dispatch. It's a great way to be introduced to the world of contrarian investing.

29 thoughts on “Gold's "Contrarian Moment"

  1. After yesterdays outside day down in gold and silver we are now to watch and see if the 18 day average stops them on the bounce, or if they can turn around and take out yesterday's highs.

  2. There is no need to have preconceived opinions, well or ill, contrarian or not, about gold or anything. Just follow the trend. And if you believe that gold is going to have a monster rally because of debt and blablaba, wait for the trade trianges. Gold won't go to the moon unnoticed! Meanwhile there are plenty of other markets to trade. It doesn't have to be gold!
    By the way, Europe doesn't look good at all, it may have a mega Lehmann moment. The first Lehmann moment didn't send gold to the moon, did it? The buying opportunity come months later.
    If you want to have an idea of the global mood, look at (and trade if you wish) a few currencies USD/EUR, USD/RUB, USD/CZK, USD/AUD or JPY versus the same. Not pretty at all. If you want to get really scared, look at the Spanish stock market DWES. And if Spain was the second (first was Greece) in a line of dominoes? Where would the line of dominoes end, you reckon? The Germans just continue moralizing about government debt, while the house is burning! Henri (UK)

  3. when moody's n fitch follow SnP with a US debt downgrade.......all pensions[and many others] by mandate will exit US debt EN MASS. over..........with stocks going down TOO in such an event.....

    gold/silver climb to new highs.

    1. Boatman, see every down turn in the market and look what gold did. Start with the 1930's.

      1. i guess u think the US has no sovereign debt issue.

        did u miss last july??????? that was a warm-up.

        this is not a 'turn down in the market'

        this is the 40 year debt/credit cycle reset.

        do you think they can 'volkerize' it like they did in '80?????....even paul himself says thats not flying.

        try financing US debt at even 8% n run the numbers.

        just a downturn in the market..........??????

        we are 12 years in a secular BEAR stock market.look up those numbers.

        gold/dow reaches between 1/1 and 1/2

        i say one ounce buys the dow in 2016.

        1. and rooosie capped gold in '34.

          those who bought early made 225% even AT the forced sell rate.

        2. US governement dept and liabilities are of course bad too, so are the UK's and Japan's. Those three are the grand masters of the printing press. Japan's debts the worst by a long shot and have been for much longer. Did it kill Japan? No, but it created the 'two lost decades' with no growth (other than goevrnment debt...) and no recovery in the stock market for 20 years and super low interest rates. A model for the rest of the world, I'm afraid.

          1. japan totally a different situation...their debt is almost 100% populace financed....demographics guarranttee a blow up SOON......the aged are now a NET seller of debt after being buyers for 50 years.

            japan is a bug in search of a windshield.

            will blow up before the US......and soon.

            at this point in the world debt/credit supercycle we are NOT getting away with two lost decades.

            big bad joss is not just business as usual, henri.

          2. I don't think it's business as usual. I'm afraid the dominoes are falling, as said in an earlier post.

  4. S, Steve & Kevin,

    All other governments in developing nations and now the US the past three and a half years have had or developed Keynesian economics. They have minipulated their currencies as well as the US are going to take it up the you know what when the bubble burst. EVERYTHING and I mean EVERYTHING will go down in value except the dollar because it will increase in value with the Great Deflation of everything else and that means GOLD also. The world will be hurting and no one will be exempt from it. The socialist, the communist and now the US are all about to learn a lesson that we should have learn from the 1930's. I hope history doesn't repeat itself but to me it looks like it is going to. I am trying to not think Doom and Gloom but fundimentally everything is so out of wack around the world and I don't see how any country is willing to do what it take to get out of the hole. But that is what you get with Keynesian economics because they think Government is the solution. Well, look at Greece and you will see your future today.

  5. As of today (5-30), the USDX has retraced 61.8% of its down-move from 2010 to 2011. This fib retracement often presages a sharp trend change, implying that the USDX run is at or near exhaustion. The metals, conversely, are poised to bounce as a result, along with the whole commodities complex and perhaps the market as a whole. Food for thought.

    1. Yep, even if one's thesis is opposite, one needs to keep an open eye. Being wrong for long can be expensive...

    2. Or, after 61.8% comes 75%, 87%, 100% and 128%, oil and USO gave a pause and a nod to the 61.8% level before saying 'See ya' today.

      1. That's a possibility with the USDX, too. All I said is that the 62% fib retracement is often a bounce point. With today's afternoon reversal in gold, I'm encouraged that my take may have some merit.

  6. The last twelve months have been dramatic as fas as economies go .gold looks now a bad trade .i thought a few month`s ago that gold and silver would go on to further gains .the decline now in these two metals signals to me that there are few people that are buying and that traders that hold gold could sell out completly .forcing gold down to 1200 dollars and lower .

    1. This love trade may well be over, but it may also subrepticiously turn around when everybody has given up. There are so many markets with clearer signals and less emotion attached to them: who not those?

  7. The US will continue its monetization of its debt until at some point, probably in the not too distant future, those nations who actually have a functioning industrial base and economy, who own $trillion$ in US notes and bonds and are angrily wathcing their investments be deliberately debased, these nations will come together to collectively dump the petrodollar and put an end to the US dollar as the global reserve currency.

    The massive and unprecedented corruption and manipulation of the precious metals markets has been and remains one of the primary methods to prop up and maintain the US dollar. This has been a mistake of historical proportions. Because the US industrial base has been shipped overseas during the last 40 years, we have employed phony capitalism, creating one bubble after another, e.g. the dot-com boom, the housing market, and now Treasury notes. It is the mentality of empire and arrogance, and it is driven by (as Jim Willie h as described it) the fascist business model.

    The current (and final) bubble in US Treasury notes/bonds is being supported and driven by interest note swaps, which means that the 0% rate must remain forever, even in the face of annual $1.5 trillion US deficits, and the purchase of most of the US debt by the Fed. What a racket! But it has been exposed and the clock is ticking, ticking.

    All the traditional ways to calculate these trends have been meaningless because of the corruption involved. These are not ordinary market forces at work, it is state sponsored manipulation on the grandest scale in human history, it is financial warfare, so the charts and support levels are not going to be good guides to the bigger picture.

    What I personally wonder about is what happens when the US dollar is finally dumped. What are the geopolitical consequences, when you have a nation with a military that far surpasses that of any other nation, which is suddenly told that it is not in charge of the global money supply any more? Maybe you better store your gold in the bomb shelter . . .


  8. Since its top around $1950, Bull unwinding process started and till the time, "Distribuation"continued and even further too, process will be same.

    After gaining around 10years Bull Faze, now Gold is going for long term bear turn, May find some Bounces, but No hope for any major Bull-run.

    Rasesh Shukla - India

  9. Gold is going to go down with all other commidities. "Deflation" is what the Fed is worried about. NOT Inflation or Hyper-Inflation. When the ball starts to roll down hill with a burst of the Government spending bubble look out below because there could be no end in site. Is this the beginning of it? I don't know but Gold as well as everything else of value will go down. That will make the value of the dollar come back because when it is all said and done the dollar will be able to buy a whole lot more. The free market has a way of correcting the imbalances that Government creates. This is why through out history for thousands of years Governments come and go. It's best if they stay the ____ out of the way and let the free markets correct. Freedom and Liberty is the solution to the Human Condition NOT GOVERNMENT!

  10. Gold and silver are the only place to hide as we are witnessing the
    death of fiat currencies. When the dominoes start to fall there will
    be no currency to hide in they will all be affected. There will be
    absolutely no warning of the final collapse, where do you want your
    assets?It is a no brainer for me.
    The police state that they are setting up in the USA is for an event
    they have long planned the death of the dollar.Martial law is coming
    soon perhaps within weeks. All IMO of course.

  11. everyone doesn't 'know' the western developed world is 'broke'

    most i know think this is just 'business as usual'

    even the ones that realize it think 'Mitt can right the ship'

    this path was chosen long ago.........even before nixon had to close the gold window......

    the ability of humans to delude themselves never ceases to amaze me.

    gold will be 10,000$ when the current ink-fed extend and pretend obviously fails......2016-2018.

    1. I agree boatman, most people still believe in the we can pick
      our president charade.

  12. So why isn't gold selling for $10,000 or more? Everyone "knows" that hyperinflation is coming, that we are bankrupt, that the government is going to have to print money for eternity in huge quantity, that everone else outside the US is going to have to do the same, etc.

    So why is gold only $1555 an oz?


    1. We need patience the dollar is temporarily rising due to the problems
      in Europe. It should have collapsed long ago when it hit 72.

    2. A few reasons:

      1. After 40 years being officially de-monitized and 20 years of being demonized by governments, Wall St., and main stream media, the retail investor really has no clue how to properly valuate gold as the anti-fiat currency that it is. Heck, even professionals and adamant gold bugs don't really understand all the whims and vagaries, but by averaging various metrics such as historical averages throughout history, %backing of U.S. stockpiles to currency-in-circulation, total CB supplies vs. global GDP, etc., I estimate that gold should be fairly valued at ~$3,000 - $4,000 TODAY. If the Fed were to triple M1 in the next 5 years, leading to high inflation (not necessarily hyperinflation - can that happen with a global reserve currency (or two!) and all global powers working in collusion to "manage" global trade/banking ?) that would put gold in the oft quoted and ridiculed $10,000 range.

      2. After rising 700% in the past 12 years, and the mainstream media screaming "bubble" the ignorant public is understandably wary. Funny, they weren't calling the NASDAQ a bubble when it was up 850% from 1977 to 1993. Nah, the following year's pull back was just a "correction" - you do the math...

      3. Sometimes a conspiracy is just official government policy. OF COURSE the price of gold was artificially low in the late 90's due to Central Bank selling and leasing. They made no secret of it; in fact the whole reason they passed the Washington Agreement in the first place was to limit sales that were causing the price to crash! The same can be said of silver, oil, copper and most other commodities. With an official "strong dollar policy" this necessarily means a "weak gold/commodity policy" to boost consumption while artificially and temporarily mitigating the effects of inflation, giving the illusion of prosperity and budget surplusses. The crash, subsequent attempt to re-flate another bubble in real estate and the crash of '08/'09 were just market forces overwhelming attempts by governmnent to control/intervene.

      Market forces will eventually win out again and the current mega-bubble in U.S. Treasuries and stocks WILL crash someday. But, I'd be a fool to predict when, just like I was a fool to assume that people would eventually figure out that the government is NOT their friend out to help them, but will serve themselves and their Wall St. banking interests first. However, as the process unfolds, enough sheeple will lose confidence in the fiat system (and government's ability to deal with it) so in my mind, that makes gold (and silver, for that matter) a bargain at today's price. Gold's ugly stepsister may take a bigger hit should a period of deflation/paper deleveraging occur before the spigots are fully turned on though. They give you insurance against this eventual (and entirely predictable) collapse, insurance that you hope you never have to cash in on, nothing more.

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