Trader’s Narrative

Market strategists have drawn a line and taken sides: is gold in a bubble? Jim Rogers and Nouriel Roubini had a verbal smack down via respective media interviews with the former manager of the Quantum Fund being the believer he’s always been in the power of commodities while the prophet of doom and gloom used the “b” word to describe the precious metal.

Now another pair of strategists have taken sides - although not as personal as Rogers and Roubini. Dennis Gartman, believes not only that gold is in a bubble, but that it should be obvious to everyone. But that doesn’t mean he’s necessarily climbing off the trend:

Meanwhile, David Rosenberg featured this chart to argue not only is gold not in a bubble, it is actually “cheap”:

Leaving aside the obvious arithmetic (instead of logarithmic) scale, comparing the S&P 500 index to the price of gold is a non sequitur. This is due to the incessant rise of the equity index, with that itself due to the survival bias built into the constituents that make up the S&P 500 index. And don’t forget a dash of inflation which pumps up stock prices and therefore, stock indexes. So a ratio of gold to equity prices will for the most part look like a ski hill - and be as meaningful.

I’m also puzzled why Rosenberg is so bullish on gold since he has been one of the prescient strategists who has beaten the deflation drum the loudest.

Market Measure of Forward Inflation
Other than the CPI figures from the US government sources, there is a market determined inflation measure. It is the implicit inflation as per the Treasury Inflation Protected Securities (TIPS). The TIPS data that I showed back in 2008 is no longer published by the Fed. Thankfully, Bloomberg disseminates a metric based on the nominal forward 5 years minus US inflation-linked bonds forward 5 years. So basically, this is the average inflation that the bond market expects from 2010 to 2015:

Source: Bloomberg

In the final days of last year, inflation expectations were the lowest in a very long time, fallin to just 0.41%. Earlier this month they reached 2.89% but today’s forward inflation expectation was still a muted 2.68%. Clearly, the bond vigilantes are not signaling a runaway inflation debacle in the near term future for the US.

So can it be that gold is in an honest to goodness bubble?

Gold Sentiment
Here are two measures of sentiment for the precious metal. The recent survey of Bloomberg terminal users on their conviction for gold found a remarkable 94% to be bullish.

That is a new record high since the survey started in 2004. Unfortunately, Bloomberg’s survey hasn’t been very good as a contrarian indicator. But it has rarely been above 90%. The closest it has gotten to this level was at the start of the year in January 2009 when it reached 91% bullish. Back then, gold was $900/oz. While there is a short history, the sheer lopsidedness of the recent consensus makes it noteworthy.

Courtesy of Elliott Wave, we get another measure of gold sentiment:

The Daily Sentiment Index (trade-futures.com) has been at, or above 90 percent gold bulls since November 3, a string of 10 straight days. The only other comparable streak of optimism over the past 22 years of data is leading up to the December 2, 2004 gold high when the DSI was at, or above 90 percent for 20 consecutive days. At that time, prices made a high at $458.70, declined over 10 percent, and did not exceed the December 2004 high again for the next 10 months. But during this entire 20 day stretch, optimism never reached the single day extreme that today did, with fully 97 percent of traders optimistic on gold’s future prospects. This time, we expect a larger decline, one that lasts longer too.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Elizabeth Warren on the Economy & Stock Market
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The above is a small sample, for the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back during the week as there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

A little while ago I tried to separate the effect of the weakness in the US dollar on the price of gold to determine whether gold’s bull market could actually stand on its own: US Dollar’s Weakness or Gold’s Strength?

There is a better index out there to determine this very question. The Kitco Gold Index is the price of gold measured not in terms of US dollars, but rather in terms of the same weighted basket of currencies that determine the US dollar index: Euro (57.6%), Japanese Yen (13.6%), UK Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and Swiss Franc (3.6%).

So instead of pricing gold in the unit of a US dollar, the chart below charts it in the the same unit that we use to measure the US dollar index:

Source: Kitco Gold Index

This is the one year comparison but you can also see a 5 and 10 year chart (follow above link). These both tell the same tale. There is definitely a bull market in gold. But, it has been aided and abetted to a large degree by the weakness in the US dollar. Seen through the lense of other currencies, the gold bull is much more tame.

If you look at a very long term chart of the comparison, it becomes obvious that there are periods where the price of gold in US dollars shoots up only to come back in line with the currency basket. Right now is one of those times.

As you can see, the price of gold in the currency basket has yet to breach the high it set earlier this year. This was something I pointed out when others were focusing on the breaking of the nagging $1000 resistance: Major Non-Confirmation in Gold.

Also, the purest equity proxy for gold, the Philadelphia Gold Bugs Index (HUI), has yet to surpass its highs from last spring (March 13th 2008 - 515). According to the k-ratio analysis of the gold sector, this suggests that gold is ‘overvalued’ relative to gold stocks.

Last week we looked at the breadth of the gold stocks which showed about 80% of them closing above their short term moving average. Here’s an updated chart:

While gold stocks managed to eke out another positive day, breadth slipped from almost 90% to below 80%. Usually, in the past, when breadth has been this stretched, and heading down, there is a good chance that a short term top has been already made.

The poor besieged dollar gets a short reprieve as the gold bull market pauses. But the gold bugs suddenly have an unexpected and persuasive ally in their camp. As an interesting addendum to what’s next for gold? in the most recent quarterly client letter, Paul Tudor Jones II builds a fundamental case for a long term bull market.

He compares the relative historical value of the precious metal to the US monetary base, crude oil and the S&P 500 index. Their econometric model declares “gold is 20% undervalued over the next 24 months”. But the rationale is not restricted to the monetary forces which are at play.

Strengthening his case, he delves into the basic demand and supply of the commodity. On the supply side, mining production has been stagnant for the past 10 years. And central bank selling has slowed to a trickle with no new sales planned in the future.

On the demand side, the physical investment allure of gold continues strong. As well, to that we can add the penchant of modern investors for digital investment in gold. Relative to the gargantuan size of the equity market, the bond market and alternative investments (real estate, timber, etc.) gold’s share continues to be lilliputian. This means that even a sliver of asset flows diverted to gold will dramatically alter the equation.

Source: Tudor Investment 3rd Quarter Letter

Gold ETF holdings as a ratio of above ground stocks has increased incrementally 4 years. And the trend, does not look like it is about to reverse.

While Paul T. Jones presents a text book case for the long term bull based on fundamental analysis, I can’t help but think it is all an elaborate window dressing to rationalize a position he has arrived at through other, shall we say, more esoteric means. Clients obviously prefer logical, well thought out reasons for why a professional is allocating their money a certain way.

No one would be comfortable to be told that their trust fund is being gambled on nothing more than squiggles and trend lines or better yet, something called Elliott Wave (which we know, by the way, that Paul T. Jones II used to make a killing on Black Monday while practically everyone else on Wall Street was busy having an aneurysm). Interestingly enough right now Elliott Wave is bearish on gold.

This is just speculation on my part, of course. I have no way of knowing exactly why Tudor Investments is bullish on gold. Maybe I’m too cynical and we can take them at face value. In any case, even if the long term gold case is solid, you might want to fine tune the entry by looking at the gold sector sentiment.

Here is a chart comparing the price of gold and the Hulbert Gold Sentiment Index, which measures a subset of newsletters which time the gold stock sector:

Source: Risk Management and Convex Return Profiles

While the Hulbert gold sentiment metric isn’t as high as we’ve seen it historically, at these levels it does not bode well for another leg up. At least not without a pause first. As I mentioned before, to me it isn’t just the altitude of the bullish sentiment, it is also the attitude: as gold has corrected recently sentiment continues to reflect the same amount of optimism.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

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• Why Big Banks Should Be Broken Up, But Why White House & Congress Don’t Want To

The above is a small sample, for the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back during the week as there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead: