July 5, 2013
Chad Karnes, Chief Market Strategist
Price bubbles usually take different paths when they form.
Some of them such as the Dutch Tulip Bulb Mania were built strictly on speculation, the .com bubble was built on the expectation of new, game-changing, technologies and productivity, and other bubbles, such as the recent housing bubble, were built on easy money and economic policies.
Regardless the reasons for their formations, all bubbles have the exact same ending, a quick reversal and rush for the exits when the inevitable party ends. Fear is much stronger than greed, and it shows as bubbles form and then ultimately pop much quicker.
And, although we may not always know in real-time exactly when we are in bubbles, the fact that they all end the exact same way is useful information we can use when looking at the next bubble that is popping. That bubble is Gold.
Tracking Gold Sentiment
Gold’s bubble is not much different than all the others. Justifications and reasons to buy gold are very easy to find, and just like a few of the previous asset bubbles in history. The reasons stem from easy money policies, a fear of never-ending inflation, etc. But there is a problem with that analysis. Inflation is not occurring and the U.S. dollar is stronger today than it was in 2008. Unfortunately, gold bulls like to focus on what they want to hear versus paying attention to the relevant facts.
If you follow our work, you know we have been on top of the Gold bubble and pop. (See our recent articles "A Gold Forecast that Will Shock the World" and "Ignore the Gold Experts" along with our #GreatGoldCrash2013 Tweets.)
In our April ETF Profit Strategy Newsletter released when gold was still trading near $1600 an ounce, we said:
“The peak in pop culture’s obsession with gold occurred right around the time that gold prices peaked at $1900 in late ‘11. We don’t see it as a coincidence that Pawn Stars was the 2nd highest rated television show in ’11 just as another popular gold focused television show was in its inaugural season, right when gold prices topped out. There were even “sell your gold” kiosks popping up in malls across America”.
Along with some other reasons we outlined, it was clear that sentiment in gold was at a bullish extreme and helping point to a bubble in the precious metals.
Gold’s Price Confirmed it was in a Bubble
Price wasn’t helping gold’s case either as we again explained in our May ETF Profit Strategy Newsletter which warned:
“Another concern we have for precious metals is the fact they have been one of the only groups of commodities that have continued to rally beyond their 2008 price highs. If the reason to own precious metals is to hedge inflation, I would expect hedges to fall into other commodities and real assets such as agriculture, energy, and industrial metals. And that simply has not occurred”.
Since then, buying agricultural (NYSEARCA:DBA), energy (NSEARCA:DBO), or even industrial metals (NYSEARCA:DBB) was a better way to go than owning the precious metals.
The chart below shows the relative outperformance through June of those suggested assets versus gold (NYSEARCA:GLD) since that article for subscribers was published April 19. All three of these alternatives have significantly outperformed their gold counterpart.
Where to From Here?
If history is any guide and the precious metals are in a deflating bubble, it's likely gold and silver have further to fall. For starters, gold’s bubble likely started when its price made new highs above 2008’s, when it left most of the other commodities in the dust.
If the reason to own gold is for an inflation hedge, then most other commodities should fit this bill as well, so it would make sense they should perform similarly, and they simply haven't.
By late 2009 the precious metals (NYSEARCA:IAU) made new highs while most of the other commodities remained well below their 2008 peaks in price. This leads me to believe that gold and silver (NYSEARCA:USLV) will need to pullback to at least those levels to relieve the bubble that was built the three years leading up to the 2011 top.
The easiest way to see this is through a chart of all the commodities. This final chart was one included in our May Newsletter when Precious Metals were up over 49% since 2008. I have updated it through June. Today precious metals are still up 29% since the 2008 lows, and still well ahead of most other commodities (livestock is the one outlier).
This means the bubble could have more room to deflate.
A price of $1,000 would not be unreasonable in such a scenario. With most other commodities still down in price from 2008, it isn’t crazy to think that the precious metals should also return to similar levels. A fall back to $1,000 would put gold back at 2009 levels.
Silver (NYSEARCA:AGQ) is in a little better situation, having already fallen back to 2008 and 2009 levels. However, for silver and gold to get back to the 2008 price equivalents of most other commodities, they would still need to fall around 30% from current levels as the chart above suggests.
The ETF Profit Strategy Newsletter uses common sense, sentiment, and technical analysis to stay ahead of the gold bubble as well as other prevailing market trends. Also included is our twice weekly Technical Forecast which keeps abreast of the shorter-term trends in the stock, bond, currency, and commodity markets.
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