My Investment Thesis on Gold

Every investor has to make their own decisions. In my view, this is a good time to consider buying gold. There may be more downside but, to me, the risks are to the upside. Given what’s happening in this world, you probably should own more gold at these levels.

Here’s a summary of my thinking:

  • Gold is at, or close to, a bottom.
  • A normal correction in gold has been extended and deepened due to expectations that President Trump’s economic program will drive faster U.S. growth, faster inflation and a more aggressive rate hike cycle that will strengthen the dollar.
  • The expectations of the Trump plan are unrealistic.
  • The Trump plan will likely not be passed.
  • The Fed rate hike cycle will not be aggressive and the dollar will falter. More QE is likely.
  • In any case, Fed rate hike cycles are not historically negative for gold.
  • The E.U. banking system represents a very significant undiscounted risk to financial markets.
  • Gold is the best available hedge against a failure of Trumponomics and loss of confidence in central bank omnipotence.
The Year in Gold

Gold hit its bear market low in mid-December, 2015 one day after the Fed began its first rate hike cycle in more than 10 years. Since 1971, gold has always declined into the beginning of a Fed rate hike cycle and has always gone up as the rate hike cycle unfolds (more on that later).

The gold price gained momentum in 2016 despite a perceived deflationary environment which was largely negative for commodities. A major factor was increasingly negative real interest rates at the short end and all along the curve. The short end is what matters most to gold because the decision to hold gold reflects the opportunity cost of holding it versus cash.

Gold reached its high in early July as the 3 month Treasury yield bottomed (double topping in early August). In July, momentum in gold reached severely overbought levels. Open Interest on COMEX set a new record high of 660,000 contracts. GLD was adding gold at a record clip. A correction was clearly needed. Gold failed several times to break above $1370 and began to leak.

Gold came under pressure beginning in September as the market began to anticipate a Fed rate hike before the end of the year. In effect, the market was anticipating an increase in real interest rates from historically low (negative) levels. The correction proceeded more slowly than expected due to a resistance on the part of Managed Money longs to dump their positions and go short when the usual moving averages were broken.

The correction accelerated and then overshot the usual parameters with the surprise Trump election result. Open Interest is now down 270,000 contracts, gold’s RSI is at bear market lows, GLD has bled gold profusely, the 3month Treasury yield RSI is at near record highs and other sentiment measures such as the HGNSI at -12.00%, MarketVane’s bullish consensus at 46% and the GDX put/call ratio (exploding on the back of massive put buying in December) are all at levels that suggest a bullish turn could be near. Gold prices have now fallen 20 out of the last 25 days, so the decline is getting pretty extreme.

The COT commercial net short position fell another 8 percent to 154,944 contracts on Friday December the 9th, which is the lowest since 131,984 contracts on Feb 16th. Also of note, gold has made four distinct new closing lows since November 14 but GDX has not made one. This has been an uncommonly clear bullish indicator for gold historically.

More on gold on Monday.