Are Gold Bugs Sweating Bullets Over February?

It was not exactly a lovely February for gold bugs. Between talks of a great rotation into risk-on assets, and confusing language from the Federal Reserve, the precious metal experienced heavy-selling pressure to reach new multi-month lows. However, gold investors may not be sweating the decline like some expect.

In late February, the price of gold dropped below $1,600 an ounce to its lowest level since July, and even trigged the headline-grabbing death cross status, a bearish technical term for when the 50-day moving average crosses below the 200-day moving average. While multi-year high equity prices have been promoting riskier assets, the decline was aided by the latest Federal Open Market Committee statement creating fear that the central bank may end quantitative easing programs sooner than expected.

Headlines hit publications across the board touting the weakness in gold and questioning the 12-year bull market. Goldman Sachs, the bank that recommended clients sell Heinz shares before the announced buyout by Warren Buffett, added to the pessimism in gold by slashing its price targets. The bank now has a three-month target of $1,615 per ounce, down from $1,825. The six-month and 12-month targets were also cut to $1,600 and $1,550, down from $1,805 and $1,800, respectively.

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The over-whelming wave of negative sentiment has not been completely unjustified, as managers and other large speculators recently decreased net-long positions in gold contracts and options by 40 percent, the most in more than five years. However, when everyone is on the same side of the boat, it is usually best to run towards the other side. This contrarian line of thinking applies to many kinds of assets, especially gold.

Gold’s recent pullback is not the first correction it has seen in its historic bull run. At the beginning of the financial crisis in 2008, gold fell from $1,000 to $700 per ounce, while silver plunged from $21 to $9 per ounce. In 2006, gold stumbled from $725 to $570 per ounce and silver fell from $15 to $10 per ounce. In both cases it took the precious metals more than a year to fully recover, but the sell-off provided buying opportunities for patient investors seeking to diversify their portfolio with a no counter-party risk hard asset.

In the immediate short-term, a contrarian stance on gold has already been successful. Gold has bounced from last week’s low of $1,569 an ounce to climb back around $1,600. On Tuesday, the precious metal logged its best day of the year, as Ben Bernanke delivered the Semiannual Monetary Policy Report to Congress.

The Fed Chairman reiterated the central bank’s pledge to keep interest rates ultra-low until “at least as long as the unemployment rate remains above 6.5 percent.” He also signaled more bond-buying by defending quantitative easing programs and said the FOMC will continue with purchases until there is “substantial improvement.”

Bernanke added that the benefits of bond-purchases outweigh the risks associated with the market intervention. “To this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation,” he said.

Despite worries about the Federal Reserve ending its loose monetary policies in the near future, Bernanke provided an outlook that still has the central bank propping up financial markets. This reminds investors that in the bigger picture, nothing has truly changed, and the financial landscape going forward will likely be very supportive to higher gold prices, but that does not mean pullbacks will be not be seen along the way.

As legendary commodities investor Jim Rogers warned in December, “Gold is having a correction— it’s been correcting for 15-16 months now— which is normal in my view, and it’s possible that the correction is going to continue for a while longer…gold on any kind of historic market basis is overdue for a nice correction.”

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Disclosure: Long EXK, AG, HL, PHYS