Sunday, January 25, 2009

Answer: Gold. What's the Question?

Amazing to me how many friends and family in the last 24 hours have passed along articles and advice from gold bugs talking about how big an inflation problem we're going to have (and suggesting that now's the time to buy gold). Eventually of course they'll be right (and maybe we'll even see a mini gold rally in the near term), but like Joseph Kennedy's famous quip that you know it is time to sell when the shoe-shine boy offers stock tips, I'm taking this talk as a sign that there will be opportunity in the coming weeks and months in inverse commodity funds like GLL (2x Gold Inverse).

Gold is going up because of general fear and an almost religious form of mass delusion. Inflation isn't here and won't be back this year, but if you want an inflation hedge, oil or natural gas are priced awfully cheap right now and there are lots of ETFs available to play that angle with less downside risk. Fine, say another group of gold bugs, but gold is also a deflation hedge, and we're seeing deflation now. So you should buy gold to protect against deflation. This was certainly true during the last century as the gold standard for various currencies distorted markets in ways that forced its price artificially higher, but I have yet to hear a solid argument that still holds today that doesn't at its heart depend on the perpetuation of the gold religion.

Like any religious movment, as you begin to ask more questions of different community members you are quickly faced with the quandry of falsifiability. This is what divides religion from science, and why the gold bugs are nearer the former than the latter. There is no theoretical evidence of any type that would falsify the gold bug belief in the accumulation and purchase of gold, be it deflation or inflation, a return to a normal business cycle or descent into anarchy. If your investment thesis isn't theoretically falsifiable in the face of any class of conflicting evidence, then you are investing via mass delusion. In the history of such episodes, it is rare to find a true believer who has successfully avoided the catastrophic end. But there are always a few fortunate ones who accidently exited near the top with some fantastic gains.

When will the gold bubble pop? My guess: as soon as the irrational fears gripping the financial system subside and most Americans come to see the timid return of inflation as the welcome early signal for recovery. The day and month nobody knows, but there's a decent chance it happens this year, and when it does, I'm planning to ride the GLL money train all the way to the bottom the same way others rode FAZ and SKF earlier this year to the recent bottoms in financial stocks. I predict we'll see an unexpected and sustained rise in oil coupled with an equally unexpected and sustained decline in gold at some point later this year or early next as those that bought gold as an inflationary hedge realize that subsiding fear makes it an underperformer compared to oil.

Could I be wrong? Of course, and I'm willing to throw out my investment thesis if its hypotheses are proven wrong by unanticipated factors and realities. That's called falsifiablility, and I don't like to invest without it. There is no falsifiability in gold right now - Peter Schiff is perhaps the most recent poster child for the way this movement operates, and the inability of his gold-bug followers to profit from the financial system collapse is just as striking as his much-lauded accuracy about its root causes.

Am I telling you to short gold right now? No, for the simple reason that we would just as foolish to bet against more mass delusion right now. But what I am saying is that the set up for a huge fall is coming together nicely, and at some point the dam will break big and the smart money will be on the opposite side of that trade. I intend to prepare for that day with small offsetting positions both ways that let me stay close to the action for the volitility trade in the near term and some cash at the ready to jump in bigger soon after the gold bugs declare a premature victory.


  1. "irrational fears gripping the financial system "

    Are you sure they're "irrational"?

  2. Fair question - some of the fears are indeed rational. But there are a great many that will prove to be overblown. My point is that once we see real capitulation with the financials and get past the raw fear, the Gold trade will stall and at some point a major downward correction is inevitable. I believe that correction will happen long before inflation enters the picture, so if you want an inflation hedge you're better off trading oil or gas right now.