If you’ve ever thought about buying gold, but never quite got round to it — in the space of a week, the market just gave you three huge reasons to ‘back up the truck’.
The incredibly bullish set up is at direct odds with the poor price performance, which saw gold dip as low as US$1540 last week.
This dip in the price is our friend: after all we’re meant to buy gold ‘on the dips’.
So when gold pulled back last week, I put my money where my mouth is…
Here’s part of the latest addition to the Cowie retirement fund:
And if it gets cheaper still, I’ll buy more.
Let me explain what I’m seeing that makes me think a turning point is getting close…
What to Do When Investment Banks Say Sell
Back in late 2008, institutional analysts were tripping over themselves to downgrade their forecasts on gold…right before gold started a 180% rally.
The fact is that consensus institutional forecasts on gold have been consistently wrong for the last ten years. You could trade gold perfectly by doing the exact opposite to what the big investment banks recommend.
In other words, when they say ‘sell’…you should buy.
So it’s exciting to see more and more big banks are calling gold a ‘sell’.
Last week, the gold forecast that got all the attention was from Societe Generale (SocGen), a French multinational banking company with a market cap of around $20 billion.
They called for gold to drop to $1375/ounce.
Frankly I’m surprised that the market paid so much attention to the SocGen report. But it popped up across the mainstream financial media, as well as financial blogs and other newsletters. It was emailed to me about twenty times.
Most commentators quoted it as though it was gospel! Yet no one seems to have checked out SocGen’s insanely bad track record on gold…
I’d like to share with you what I wrote about this in a snippet from the Diggers and Drillers weekly update from last Thursday:
‘The 27 page [SocGen] report was called ‘The end of the gold era’, making the case for gold to fall as far as $1375/ounce.‘Everything about today’s gold market reminds me of late 2008: the fundamentals, the technicals, the bearishness, the institutional downgrades, and the market action.
‘And now we have Jesper Dannesboe, who co-authored this week’s Soc Gen report, who also got it tragically wrong back in 2008. I’ve dug into the archives for you to show you what he was saying back then.
SocGen sell to be a contrarian indicator to buy again?
| Oct 31 2008 | Context: Eight days after gold bottomed out at an intraday low of $680, and at the start of a monster rally that took gold to $1920 over the next three years: ‘The most likely scenario for gold is it goes down a lot, especially if it is trading at historically high levels … Because the fears of inflation will be replaced by fears of disinflation and that is a killer for gold … I think gold is going below $600 in this cycle.’ Source |
| Nov 18 2008 | Context: Gold was at $740, and would jump 11% to $820 within a week: ‘The bullish story on gold based on fears of inflation is dead,’ Source |
| Jan 6th 2009 | Context: Gold was at $840: 24% above its intraday low of $680, and at the start of a three-year rally that would see gold gain 182%. ‘Gold should be sold into rallies’ Source |
‘Well…there were three years of rallies to sell into, which should have been plenty! This is what SocGen’s calls look like on the chart.
‘Then last year they called gold to soar to $8500, and it fell.‘So, their latest call for gold to fall could well be the best reason to buy that we’ve had so far!’
In short — SocGen taking another swing against gold with the same weak argument that it had back in 2008 is a clear warning signal that a rally could be imminent.
Since I wrote the above, the guys at Sprott Asset Management took SocGen’s argument to pieces. Part of their rationale brings me to the second big reason to start buying gold now.
(NB: you can watch my recent interview with legendary investor, Eric Sprott, by taking out a subscription with any Port Phillip Publishing paid investment service. Check out our latest offer here… )
You see, last week we heard that the Bank of Japan will DOUBLE their balance sheet over the next few years.
Where This Goes, Gold Follows
This is quite simply a game changer for the entire market: everything from bonds to foreign exchange, commodities, and equities.
But it’s gold I want to focus on today. There is a tight relationship between gold and the collective size of central banks’ balance sheets.
As balance sheets swell, gold rallies. You can see how closely the two track each other below in the chart from the guys at Sprott Asset Management.
Gold Moves With Central Bank Balance Sheets
Right now the major central banks have $9 trillion on their books — and Japan wants to add $1.4 trillion to that number by the end of next year.
If the relationship holds true, this would convert to a 15% increase in the gold price.
But hang on…didn’t we use the same rationale about the US Fed last year? Wasn’t the growth of their balance sheet meant to push up gold?
Well, the Fed has bought $85 billion worth of US Treasuries and mortgage-backed securities a month, and gold has gone nowhere fast. But you’ll get your explanation if you look closely at the chart above. You’ll see that the total balance sheet has actually pulled back slightly in the last few months.
Surprisingly, it’s because the European Central Bank’s (ECB) balance sheet has in fact shrunk by 10% this year.
This would explain why gold has had a rough start to the year. The ECB’s contraction cancelled out the Fed’s expansion.
However, the ECB’s balance sheet has stabilised now, and with Slovenia and the Netherlands lining up to be the next Cyprus, it could be on the way back up very soon.
Even if it shrunk at the same pace again, it would be easily exceeded by the combined growth in the balance sheets of Japan ($75bn) and the US ($85bn) of $160 billion/month.
Assuming no change from the ECB, and that the Fed and the Bank of Japan keep going at the current pace for another two years, this would equate to a balance sheet expansion of $3.8 trillion. This would add over 40% to the current global balance sheet of $9 trillion. As gold moves so closely with this, you could expect a roughly 40% rise in gold.
It’s dangerous to look exclusively at fundamental drivers, and ignore the positioning in the futures market.
And this is where we get the third major reason to buy gold today.
The Commitment of Traders Report
This report analyses the positioning in the futures market, which — right or wrong — determines the price, at least in the short-term.
And there is a keg of dynamite under the price here right now: there are a near record number of traders (‘managed money’) trying to short gold.
Just like journalists, these guys basically get it wrong every time. You can use them as a good contrarian indicator.
To show you their near perfect record of getting it wrong, I’ve highlighted (in red circles) the times they have stacked on the biggest short positions in the last five years. Then I’ve highlighted the corresponding periods on the gold chart (green circles on pink line). You can see that each spike in shorts has signalled a rally in gold.
Traders Shorting Gold — So Get Ready for a Rally
Take another quick look at the chart. The two big spikes in shorts back in 2008 preceded the three year rally in gold. And you can see that today’s short position is at far higher levels than back in 2008. It’s at record levels, and has been for a few weeks now. This is a highly explosive situation.
I suspect we’ll see volatility both ways at first as they defend their trade, but almost certainly this ends in a big move up.
Because there is a real chance these guys are going to have to ‘cover their positions’ if gold rallies just a little bit. Each trader doing this will raise the price, and cause another trader to follow suit. They are like a large group of mountaineers all tied together with the same rope. When one falls, the rest will follow in spectacular style. It would be enough to cause a massive move in gold.
Watching the gold price trending calmly down, you’d never imagine a war was waging below the surface of the market.
But a war it has been — and one that gold bulls are about to win.
Dr Alex Cowie
Editor, Diggers & Drillers
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