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The Only Reason to Short Gold

December 17th, 2012
in gold

by Cliff Wachtel, Global Markets and The Sensible Guide to Forex

Gold’s loss of momentum in the past months has predictably brought out calls to short gold.

Here’s a brief guide to whether you should consider or ignore these.

Follow up:

FIRST UNDERSTAND WHAT GOLD IS AND WHAT IT ISN’T

As I’ve discussed repeatedly in both my articles over the past year (most can be found here or here), and in depth in my recently published book, there is widespread confusion about what really drives gold and what kind of asset it really is.

The short version:

  1. Gold is neither a risk asset (an asset that rises in times of optimism about growth like stocks) nor safe haven asset (an asset that rises in times of the opposite sentiment).  Rather it is primarily a currency hedge, which rises in times of concern about the long term value of the most widely held currencies like the USD and the EUR.
  2. A currency hedge is not the same thing as an inflation hedge (which gold is not). The concepts are related, and inflation is correlated to currency depreciation, but the two concepts are not the same. For example, over the past decade in which gold has rallied to new highs, inflation in the US has been relatively low in the past decade, but the USD has steadily lost value relative to most major currencies.
  3. There are relatively brief periods when this rule doesn’t hold. For example in times of great market panic it tends to get dumped as markets flee into safe haven currencies.

DEMAND FOR GOLD AS CURRENCY HEDGE

Given the above understanding of gold, you want to be overall long gold when the currency to which most of your wealth is linked is at risk of debasement. Again, this article is meant to be a quick guide, so let’s just briefly consider the broad outlines of that risk.

The policy makers behind the USD and EUR, the two most widely held currencies, have indicated in both word and deed that they are ready to print money in virtually unlimited quantities for the foreseeable future in order to prevent recession or worse. They have not made material progress in curing the root causes of their economic woes, and so it’s reasonable to expect them to continue undermining these currencies. The solutions are known but politically impossible as long as the elected leaders continue to place a higher priority on retaining power than on imposing solutions that would be painful enough to get them voted out of office

Policymakers behind the JPY and GBP are heading in the same direction for essentially the same reasons. They can’t cut back spending without imposing so much pain on their voters that alternatives to money printing are politically impossible at this time.

It’s not surprising then, that those in charge of the leading export economies and sovereign wealth funds are moving out of these currencies as quickly and quietly as they can (admittedly not so quickly or quietly given their size and need to avoid undermining both the value of their remaining holdings and exports).

Given that the above economies have yet to make meaningful progress of to solve their debt crises, this same long term fundamental demand for gold as a fiat currency hedge, and thus gold’s up trend, remains in place.

OTHER FUNDAMENTALS THAT SUPPORT GOLD

These are well known, so let’s just list some of the big ones

  • Central banks continue to add to gold reserves.
  • The populations of China, India, and other higher growth areas continue to be gold buyers.
  • Per The World Gold Council, supplies of physical gold slightly exceed demand. In theory, there is many times this supply sitting in stocks and other equivalents.  Much of how you view this data depends on how much you believe the stated physical supply figures are not materially overstated and that the paper equivalents will continue to accurately track the price of gold in times of exceptional demand. Suffice to say there is reason to wonder. For example, while no one is making any public accusations, a number of nations, Germany among them, have felt a sudden need to audit their gold reserves held abroad. Were there a, ahem, material exception, do you really believe Germany would be quick to go public about it? Given the implications, would you, were you in their position? Just asking.

In sum, all of the fundamental drivers of gold’s decade-plus rally remain in place.

TECHNICAL PICTURE

Gold’s long term chart reflects the above fundamentals.

Looking at a weekly gold chart of the past two years, it’s clear that gold’s long term uptrend remains intact. That’s not a trend to fight until it’s decisively broken.

In particular:

  1. The downtrend from that high was broken in August, and is still trending higher since then.
  2. Its pullback from its all time high in 2011 shows no sign of being anything but a normal technical pullback. As of this writing it’s down about 10%.
  3. It’s long term support zone, defined by the area bounded by its 20 week (yellow) and 50 week (red) EMAs continues to hold and trend higher.
  4. Strong support is around 1570, less than an 8% drop.

THOSE WHO SHOULD CONSIDER SHORTING GOLD

Short Term Traders

Like any asset, gold moves up and down within its overall long term trend. That very reachable 8% downside is plenty of room for short term traders who plan on opening and closing positions within a matter of weeks at most, based on a clearly defined set of technical criteria for determining short term strength or weakness, and you’re either monitoring your positions closely or have entered entry and exit limit orders in advance.

THOSE WHO SHOULD NOT SHORT GOLD

Anyone Who Doesn’t Fit The Above Criteria

In other words, unless gold decisively breaks strong support around 1570, you’re either holding current positions or buying on dips somewhere around 1600, depending on personal considerations.

THE BIGGER LESSON IMPLIED

wachtel-book-sensible-forex-150x200For those with significant exposure to currencies at risk of severe long term debasement, you need cut your exposure to them as much as you can, and increase exposure to currencies and assets that will benefit from the decline of the USD, EUR, JPY and GBP, among others.

Their coming decline is not some wild speculation. For example, it’s been a reality for those based in US dollars for decades. See 7 CHARTS TELL WHY WE ALL NEED CURRENCY DIVERSIFICATION for details.

There are some fine points to implementing the above, which I discuss in my articles and book in greater depth. For example:

  • The USD remains the safe haven of choice in times of great fear. These periods are likely to occur as long as the assorted debt crises in the developed world remain unresolved.
  • The preferred USD denominated or linked assets are those that are most resistant to loss of purchasing power as possible. The same holds for those needing to be liquid in EUR, JPY, or GPB.
  • Those seeking to build a reliable income passive income stream want to buy quality dividend stocks that pay you in the better managed currencies that will rise against those mentioned above, like the CAD.

See prior and future posts for more, as well as the book.  Click on book picture for more information at Amazon.com and to order.

A PARTING QUESTION

What are your favorite ways to hedge currency risk? If gold, what specific plays? If something else, be it oil, or certain kinds of stocks or other instruments, what in particular do you favor for longer term protection against debasement of your USD, EUR, JPY, or GBP.

 

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.









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