Is it time to quit on gold?
Editor's note: Longtime readers know of our admiration for John Doody... He's one of the world's best gold-stock analysts.
As we explained in the past, John uses a proprietary approach to valuing the largest gold-producing stocks based on their production and reserves. Based on his methods, John publishes a Top-10 list of gold stocks. As he explains below... following the recommendations on his Top 10 list has produced exceptional gains.
Given the recent selloff in gold and gold stocks, we thought Digest Premium readers would want to hear his opinions. John gave us permission to publish the below piece, which he sent to readers of his Gold Stock Analyst newsletter.
Gold fell $84/oz. an ounce on Friday to close at $1,477/oz.
Before anyone throws in the towel, some perspective: Friday's was a 5.4% drop, the same as a $10.00 stock falling to $9.46. A reason for hara-kiri? I don't think so.
From its all-time (London fix) high of $1,895 on Sept. 5, 2011, gold is off 22.1%... the $10.00 stock has fallen to $7.79. A better reason to quit gold? I still don't think so.
For perspective, Apple's stock peaked at $702 on Sept. 19, 2012 and closed at $430 on Friday, down 38.7%, but no one is suggesting spiked Kool-Aid for all.
We have seen similar downdrafts before in this gold bull market. As shown in the chart, the two prior times the metal fell -22.6% and -29.5% before rallying to higher highs.
In the 1970s bull market, gold climbed to $185/oz. on Feb. 24, 1975 and 18 months later, August 25, 1976, it had fallen 43% to $105/oz. We all know it rallied over the next 5 years to $850/oz.
The end of the 1970s gold bull market at $850/oz. is completely explained by [Federal Reserve then-Chairman Paul] Volcker's raising interest rates in Jan. '80 higher than the inflation rate. That ended the negative real interest rate environment of the 1970s that had driven investors to gold. Positive real interest rates, where risk-free returns are greater than the inflation rate, are always gold's death knell.
The laws of economics have not been repealed. The Fed head [Ben] Bernanke told us quantitative easing (QE) continues until 2.5% inflation or 6.5% unemployment. The Japanese are now doubling their money supply trying to jump start their own economy. Europe teeters on the edge of recession.
Are the "powers that be" toying with the gold price attempting to break it as an economic thermometer? Maybe. Gold is money, and all central banks interfere in the foreign exchange markets. But just as [legendary hedge-fund investor George] Soros broke the pound in 1992, there aren't enough fingers to keep plugging the holes in the dike forever.
As for gold stocks, we own them for their leverage to gold price. When gold goes up, the Gold Stock Analyst (GSA) Top 10 goes up more. From the crash low in October 2008 thru the end of 2010, the GSA Top 10 was up 1,065%, 11 times more than gold's 94% gain. Unfortunately, the leverage also works to the downside.
Your editor is staying the course. I have not sold a single ounce or share. If you do not have my confidence, sell half. In the worst case, you'll be half right.
– John Doody
Editor's Note: John is currently offering Gold Stock Analyst at a discount, but the offer ends tomorrow. If you'd like to learn more about John's proprietary method for picking gold stocks, click here.
Is the bottom in gold finally here?
Our favorite precious metal has had a tough week... Last Wednesday, Goldman Sachs advised its clients to short gold, predicting it would fall to $1,450 an ounce by the end of the year.
Goldman cited waning investor conviction, net long positions in futures, and gold-based exchange-traded funds (ETFs) near all-time highs. While the investment bank's directional bet was correct, the severity of gold's drop was underestimated.
As I write, the metal is down nearly 10% for the day, hovering around $1,350 an ounce. That's a 28% drop from its all-time high of $1,895 on September 5. It's the biggest two-day drop for gold in 30 years.
While the drop is painful, remember... nothing goes straight up. Gold has posted 12 consecutive years of gains. It was due for a breather.
Still, the severity of this selloff caught the world by surprise. Dennis Gartman, a commodities trading expert and editor of The Gartman Letter, wrote this morning:
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We've traded gold for nearly four decades and we've never... ever... ever... seen anything like what we've witnessed in the past two trading sessions.
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In addition to Goldman's "short gold" call – which spooked newcomers to the gold market – China recently announced bad economic numbers. The world's largest commodities consumer missed GDP, retail sales, and industrial production expectations. Any hiccup in China's growth will cause commodity prices to fall across the board.
Also, the minutes from the Federal Reserve's most recent meeting showed some of the central bank's policymakers favor an early ending to its $85 billion a month in bond purchases. They were emboldened by a "strengthening" economy and rising equity prices. Any move by the Fed to halt its quantitative easing program is bearish for gold prices.
However, we're not worried, as the economic damage has already been done... Any further money printing is just a bonus.
Record equity prices themselves are bearish for gold... As the upward march continues, lower-conviction gold buyers will be tempted to transfer their money from gold to stocks.
Gold holdings in the SPDR Gold Trust (GLD) – the biggest gold ETF – have already fallen 22.9 tons to 1,158.56 tons as of April 12... That's the lowest level since April 2010.
Speculation that Cyprus would sell about $525 million of its gold holdings also spooked the market. While it's a small amount in the overall market, it's significant considering Cyprus owns 13.9 metric tons valued at around $622 million. So the sale would represent 85% of its holdings.
The rumors from Cyprus got markets thinking... "What if Italy and Portugal are forced to sell most of their gold? Things would be much worse..."
Finally, selling begets selling. Many institutional investors are dumping their positions. The size of the futures market (the paper market) is so large, it now dictates movements in the physical market.
And remember, all commodities are selling off today... crude oil, silver, copper, and wheat are all down. Commodity investors are getting hit from all sides. This is only perpetuating the downward cycle.
Whatever the reason for the drop, we're not selling our gold. Instead, we'll look to add more in the midst of this selloff. I spoke with Van Simmons, a leading coin and bullion dealer, this afternoon. I asked him if he was swamped today... He told me people are looking to buy... "Nobody has asked to sell yet... Not one."
Gold stocks, on the other hand, are a different story. They are just like any other equity... and you must mind your trailing stops when they fall. As DailyWealth Trader co-editors Brian Hunt and Amber Lee Mason wrote in today's issue:
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Don't get emotional about this [gold stock] trade. We know many folks make the mistake of getting emotionally involved with gold and silver trades. We don't. From a trading standpoint, we view gold and silver like we do oil... or copper... or tech stocks: As trading vehicles.
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That's why we urge you to handle this decline like you would any decline in any trading vehicle: by minding your predetermined exit strategies... by minding stop losses.
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If you've read our "Trader's Manual," you might recall Jim Rogers' excellent warning that, "Markets often rise higher than you think is possible, and fall lower than you can possibly imagine."
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We believe gold and silver stocks will eventually experience a big rally. But we can't know the future. We can't "possibly imagine" how far gold stocks will fall. That's why we recommend minding stop losses on this idea (and every idea).
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That's the key to successful trading: You make a lot of money when you're right... and lose only a little bit of money when you're wrong.
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Even the most skilled gold traders and investors have been whacked. The important thing is to cut your losses. You can always get back into a trade... provided you still have the needed capital. That's why preserving it is critical.
We believe gold could still fall from here. (The trend is certainly down.) But gold is still at its most oversold level since 1999. Eventually, traders will see a tremendous buying opportunity.
When we want to buy gold stocks, we ask John Doody. He's one of the best gold stock analysts we know. He's been through many gold market cycles, and he knows how to make huge profits when the trend turns around…
From gold's low in October 2008 through the end of 2010, John's proprietary gold stock investment returned 1,065% – 11 times more than physical gold's 94% gain.
John says he's "staying the course." In a note to his readers on Friday, he said he hasn't sold a single share. Our Digest Premium readers can view John's entire update (which he gave us permission to republish) below...
If you'd like to see which gold stocks John is recommending and take advantage of this recent selloff, click here to learn more about Gold Stock Analyst. John is currently offering his service at a significant discount. But the offer is only good through tomorrow...
New 52-week highs (as of 4/12/13): ProShares Ultra Nasdaq Biotechnology Fund (BIB), Berkshire Hathaway (BRK), iShares Nasdaq Biotechnology Index Fund (IBB), PowerShares Buyback Achievers Portfolio Fund (PKW), SPDR Utilities Select Sector Fund (XLU), Johnson & Johnson (JNJ), Prestige Brands (PBH), Calpine (CPN), Navigators Group (NAVG), Travelers (TRV), Blackstone Group (BX), Procter & Gamble (PG), McDonald's (MCD), Wal-Mart (WMT), Walgreens (WAG), Target (TGT), and Philip Morris (PM).
Capitalism is evil, huh? One reader calls us (nearly) every name in the book. If anyone knows of a good "Kantian" focused fund for him... send your suggestion to feedback@stansberryresearch.com.
"Recent recommendations from your company involved recommendations that I consider unpatriotic, treacherous, treasonous, and generally immoral in the Kantian definition. You are proving Marx right that Capitalism is an evil." – Paid-up subscriber Paul Christianssen
Goldsmith comment: We receive a note like this every few months... And we like to remind people that our job is not to be a "moral compass" in the equity markets. We simply scour the globe for equity investments we believe will be profitable for our readers.
Regards,