The End of Gold’s Bear Market

There are an unusually large number of bears roaming our neighborhood this fall, and I am not talking about stocks or commodities.

I know of two actual bear attacks since July — I guess that is not all that surprising in the Pacific Northwest. Just last week, my neighbor surprised one rummaging through my garbage in the middle of the night. On Wednesday, as I was driving back home from my usual 4:00 a.m. coffee at Starbucks, I too came face to face, or grill to bum, with a bear. It was neck deep in one of my neighbors’ garbage cans, which it had dragged half way onto the road in front of me.

It is going to be a long winter, I thought to myself, as I wondered why this big fellow wasn’t getting out of my way. Stubborn bastard. Big too. I flashed my high beams. Then anxiety began to grip me and I started worrying that it might mall my paint job if I made it mad, or even chase me into the driveway, which was just a few houses down. Should I call the police? Should I honk and wake the neighbors?

Stay cool, I reassured myself. I have raised dogs almost as big as this ole bear.

No sooner did I calm down then he moseyed on off the road, and I made my escape. Whew.

Is the Gold Bear Gone?

Talk about synchronicity, it occurred to me later that day, when we saw the gold market make its biggest one day reversal in nine years.

The bulls went straight through all manner of intermediate resistance to end up $84 at over $860 on the day, and then continued on Thursday to print a high of about $910 before the cash market settled back at around the $845 level going into the Friday morning session in Europe. Gold traded as low as $736 only one week earlier.

As in my bear confrontation before the market open, I was just beginning to think about accepting the possibility that the gold bear would not go away until next year when, suddenly, it made its exit. Or did it? Is this just another false start? A sharp bear market rally? The answer is important to your investment strategy. Stay tuned.

What Has Changed in One Week?

The ink had hardly dried on the U.S. Treasury’s socialization of Fannie and Freddie, and thus half of the U.S. mortgage market, when it realized it would have to reconvene over whether Lehman was too big to fail the following weekend. Apparently, it was not, and so began the filing of the largest bankruptcy in U.S. history.

Then the dominoes really began to fall. Merrill Lynch was taken out, and then speculation turned on AIG, Goldman, Morgan Stanley and many others. The Treasury ended up taking control of AIG, but not before giving rise to fears about the exposure of “safe” assets, like money market funds, to Lehman or AIG or whatever failing counterparty might be guaranteeing this or that in your portfolio.

The events reminded investors that there is nowhere to hide, except, perhaps, in the one asset that is “no one else’s liability” — gold. The government is grabbing at straws. The Federal Reserve’s balance sheet is wearing so thin that the Treasury is raising money for it on Wall Street now. Talk about wash trades. It is not just the U.S. markets. Loan markets are stressed all over the world. Russian markets froze this week too. The Chinese central bank cut rates and its government kicked off a plan to start buying stocks for its sovereign wealth fund to stem the bearish tide.

Despite fluctuations in expectations, the fundamentals have remained bullish for gold. The events have generally confirmed gold bulls’ warnings, and all but guarantee future inflation.

Evidence of soaring demand in the physical space has been oft reported throughout the correction.

The amount of contracts closed on futures exchanges dwarfs the real ounces liquidated by the bullion trusts in this time. On the COMEX alone the amount of contracts outstanding shrank by 10 million oz, compared with just two million ounces for the streetTracks GLD bullion trust.

Stay the Course

This move in gold does not look like a bear market rally. It looks real. In fact, it suggests that the decline through $850 last month was a mistake…that the market was wrong, as we suspected. That is, the market was wrong to think the bust was over, that central banks were capable of any kind of “tightening” or that the problems for the dollar have passed.

My general suggestion is to buy the dips and corrections. Don’t chase the breakouts. The reason is that it is not yet a slam-dunk that the Fed will inflate. We have to adopt a wait-and-see attitude.

Ed Bugos
September 24, 2008