As Commodities Tumble, Don't Count Out Gold

The commodity collapse is undeniable.

Just look to 2015 year-to-date returns: Oil has shed 16%, Nickel is down 25%, wheat has lost 15%, and sugar has plunged 28%.  Yet the plunge in commodity prices doesn’t seem to be occurring in unison with the pace of global economic activity.

Precious metals seem  the most oversold as judged by CFTC managed money speculative positions – perhaps the reasoning for Monday’s $9 bounce in COMEX August futures, which have gold at $1094.50, or $22.20 higher than Friday’s contract low price of $1072.30.

What a month it has been for gold!  It’s been slowly eroding for most of July, in early Asian trading last Monday July 20, it had a flash crash of its own, tumbling 5% to $1,100 an ounce in moments.  The unsteadiness of the price action unnerved the most war-torn trading veterans and brought fearful reminisces of golds lurches of 2013.  Consensus was marred.  We fully expected the precious metal to quietly struggle not to abruptly evaporate!  We expected gold to fall like feathers, not to stumble down a marble staircase!

Gold begins a new week just as it ended – trapped within a broad and volatile trading range – closing last week down near 3%, -6.38% for the quarter, and  -7.50% for the year. The reasons for this have been both well-signaled and supposedly sketched in stone. Gold is no longer desired as the Fed remains on course to raise rates, physical markets are dreary, Shanghai warehouse receipts show more gold than once believed, and Indian government to reverse import restrictions.  The pile-on continues as analysts and technicians spill ink with “gold falls as expected”, “any rally should be viewed as corrective”, and “no real supportive price to speak of.”

Although there have been no clear or imminent changes to gold fundamentals there’s no denying that any manufactured sentimentalities for golds rebound have simply vanished. It’s given way to a dark cloud of bearish momentum as China has suddenly lost its appetite for the metal, the Fed will be raising rates, and frankly if the recent travails of Greece won’t cause the grasping for harbors of safety, what will?

It’s no doubt the history of gold has encompassed countless kings and conflicts and its value has ebbed and flowed typically based on the fear of irresponsible monetary/fiscal policy of those governments.  As “there is nothing new under the sun,” we can add central banks to that list.

To place gold in recent context:  It rose from $35 an ounce (Bretton Woods Act) to $183 an ounce in 1974 as the US CPI fast-tracked to 12%.  Gold then sunk with inflation to $104 an ounce in 1976, before surging again during the second and more severe rise in inflation peaking at $850 an ounce in January, 1980.

The following sharp collapse in US inflation, as the Fed boosted interest rates approaching 20%, and instant appreciation of the US dollar saw an equally sharp breakdown in gold, the price retreating to $300 an ounce by the summer of 1982.  The gold price today is well over one-third below its 2011 top, and history books will someday record that much of the decline stemmed from a nagging realization that the direction of the Federal Reserve was not always going one way.  The signs were apparent – we just refused to look in the proper direction.

Our market reasoning and the items that bear it are brittle.  Reasoning accrue over time in their visible expressions, articles like gold as it rallied during QE1, stumbled through the period in-between (QE1 & QE2) only to rally again throughout QE2. And even though the trend was discontinued – i.e.,  gold made its initial descent during QE3, the trap had been set as memories do not reside in the minds isolation but are connected to objects and stored in them.

Similarly, our perception of history – the passing down of signals from event to event – makes investing more than a subjective exercise.  Consensus now believes that on September 17th, Janet Yellen will conclude the two-day meeting uttering a phrase (“The FOMC has decided to raise its target for the Fed Funds rate”) that hasn’t been dared spoken in nine years automatically recalling textbook wisdom, deeply scored into our fabric, that higher rates are a negative for gold.

It will likely provide us with that much needed comfort that finally this dismal past has turned into a better present.  It’s also a perfect example of the disenchanted version of history we believe to be true as its problematic at best to subscribe to the idea that tightening cycles are always negative for gold.  In fact, gold rallied during both of the last two tightening cycles (2004-2006, 1999-2000) and was within one 1% of unchanged during the cycle in the mid-1990’s.

Honestly, I don’t find any meaningful relationship between the Fed Funds rate, quantitative easing, physical warehouse stocks, and the resultant gold price.  And, with full acknowledgement that trends can and do last longer than I can remain solvent, that consensus doesn’t have to be wrong, I hereby change my personal “sell” conviction on gold to “buy” in/around September 17 after Fed Funds are raised predicated on nothing other than markets are no longer sitting around idling – they’ve already projected it!