October 13th, 2008
This week has been a bad week for me.
According to Market Watch, gold futures for December delivery have lost $71.30 this week, or 8.3%, in a time where the Dow essentially didn´t move (from Monday open to Friday close, it ended down -14.79 points, or -0.1%). Even though there wasn´t a strong downward or upward trend by the end of the week, one certainly couldn´t say that things were calm. After Monday´s unprecedented 900+ point gain, equity markets have been in fits of volatility.
So what´s the deal?
Theoretically during extremely volatile times, people should be flocking to safe haven investments like precious metals. Yet, during a week that would be the quintessential example of back breaking volatility, precious metals performed horribly.
The typical argument I´ve heard is that precious metals prices are falling due to deleveraging of hedge funds. Forced either to make margin calls, refund investors, or simply to maintain higher levels of liquidity, the large claim is that these funds are engaging in fire sales, including precious metals that they might otherwise hold on to. This serves to be a decent argument, since leverage reached record levels during the middle of 2007. But this isn´t the first time that I´ve seen the lack of performance in some asset blamed on fire sales by hedge funds.
Physical Demand Remains High, Supposedly
Almost every single article bullish on gold seems to cite unprecedented demand for silver and gold bullion bars and coins from central banks, leading to long wait times. The thing I always bring up is why there isn´t someone using arbitrage in the spot market of gold to serve this physical demand market. I´ve heard totally ludicrous numbers for what the spot price would be if the price of actual gold was reflected in paper markets, and it just doesn´t make sense.
If something was really that cheap in another market, you´d be stupid not to just hop in to that market (hell, if future trades are so out of whack, why don´t you just buy one and hold on till delivery?) and then sell them back to the other.
Others have cited the carry trade that exists between borrowing gold from central banks, selling that in the spot market, and then using that money (the lending rates on gold are relatively low, typically less than 0.5%) to finance other transactions. The thing that doesn´t make sense about this argument is that someone engaging in this carry trade would have to hedge their physical gold short by buying gold futures. In this regard, it´d be really easy to see the impact of the carry trade in the market: there´d be a huge gap between gold spot prices and gold future prices, favoring gold future prices. In this way, it´s kind of hard to argue why things are so out of whack.
What I Think is Going to Happen
I´ve frankly been shocked by how poorly gold and silver have performed lately. The only real reason that I can point to is the strength that the US dollar has maintained. If you´re looking for a safe option right now, you basically have Treasury bills, cash and precious metals.
Treasury Bills are more or less considered to be one of the safest instruments out there, because they´re backed by the United States´ government. A lot of people have used T Bills as the reason that the US dollar has remained so strong, since many investors have fled riskier investments overseas for the greater security of American markets (ironically). However, if you´re a fund looking at where to have your money right now, in the short term you´re likely going to avoid T Bills, since further issuing of debt by the US government will likely only serve to push yields up, thus losing you money in the short term if you buy them now.
Thus, if you´re deciding between cash and gold in the short term, your decision is going to hinge on how much liquidity you´re going to need and where the value of the currency is going. With the direction as of late, it doesn´t seem like the dollar is going to being losing value any time soon.
Because of this, if I was a fund manager, I´d be looking at precious metals and wondering why I should even bother, given that you can´t get more liquid than cash.
Because of this, I really think that as long as the dollar stays strong, gold isn´t really going to go anywhere, especially if it is true that people are unloading just about all types of assets. If we see that unloading continue much longer, and then a coincedental fall in the dollar, that could create a massive ¨gold rush¨ so to speak. Until then, I think I´m going to continue to be frustrated with precious metals.
Disclosure: the author of this article is long GLD, DGP, SLV, SIL, FCX and trying to build a position in EDD
Questions? Comments? E-mail me at thesaneinvestor@yahoo.com
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© 2008 Andrew Jarmon
If you take a look at my Motley Fool CAPS profile (blade5adj), you’ll notice that I’ve currently placed several financial ETFs as outperform and a couple of financial shorts in underperform, and after today’s dismal affair you might wonder to yourself why anyone would even touch financials right now.
For a while, it was only when the dollar was down against benchmark currencies that we’d see a pick up in the price of gold. It would appear as though investors aren’t as concerned about that anymore.
