By Vedant “VK” Mimani
I have long kept a list of warning signs I expect to see prior to the next liquidity panic, and one is gold making new highs, while silver and gold stocks fail to do so. In the past few weeks, gold had made new all-time highs, while silver and gold stocks haven’t and general markets were distressed. We now expect a couple of weeks of respite and the obligatory relief rally in broad markets to be followed by a severe liquidity panic in most everything in the next few months. We look for the precious metals complex to precede all other markets and turn down soon.
In the last two weeks, we have seen gold go parabolic and we now look for the following two weeks to show the gold move is indeed complete. Our view is that gold is near a high point that will be its top for a long, long time. Those who think they missed the gold train will have the opportunity to buy at significantly lower prices in November because a swift and severe correction is coming.
Gold at $250 per ounce (February 2001) was cheap as dirt traded insurance and warranted buying hand over fist and we put every penny we had in gold and gold stocks.
Gold at $925 per ounce (April 2009) was good insurance at fair value. At fair value, we became less interested in gold and turned our attention to gold stocks. In April 2009, gold stocks too were at fair value, but unlike gold they had the opportunity to create value by growing production, advancing projects, increasing reserves, and making new discoveries.
One note on how to fairly value of gold: I use a back-of-the-envelope calculation that takes True Money Supply from the Ludwig von Mises Institute and multiplies it by a coefficient generated by historical trade data. According to this method, fair value today is $1,092 per ounce ($728 is cheap and $1456 is expensive). Please note, True Money Supply is a dynamic figure and can increase as money is created and decrease as money is destroyed (yes, money supply can decrease as money is destroyed when bad bank loans are written down). The coefficient has two range sets depending on the market’s assessment of U.S. Government debt. And despite Standard & Poor’s analysis, the market assigns a zero probability of default by the U.S. Government. If the bond market began predicting a U.S. Government debt default, this model would value gold at $7,282 per ounces.
Another model to determine fair of value of gold has been developed by Paul van Eeden, a highly respected analyst within the gold community. His model calculates the theoretical gold value for 2011 at approximately $886 per ounce (as of November 8, 2010).
Gold at $1250 per ounce (September 2010) was expensive insurance. To buy or not was a function of individual circumstances. Further price appreciation in gold would be a function of U.S. Government debt default, hyperinflation or the Greater Fool theory. The Greater Fools came along in the form of the New York hedge funds, Asian Central Banks and retail consumers reacting to the Federal Reserve’s announcement of its second round of quantitative easing.
Gold at $1500 per ounce (July 2011) was an outright speculation on further rounds of quantitative easing, which we think the bond market will no longer allow, and of more Greater Fools. Those interested in protection against U.S. Government debt default or more rounds of Quantitative Easing are, at this point, better off in distressed U.S. residential real estate. Please note that I do not like residential real estate for a host of reasons, but it’s the better of the two options.
Gold at $1800 per oz (August 2011) is around the top; the last of the fools are in. The only way gold can go higher from here on a sustainable basis is if U.S. Government is about to default on its debt. The chance of that in 2011 is zero and in 2012 it is close to zero.
But then there are gold stocks. Gold stocks in August 2011 are cheap because the best companies have created value over the last 2.5 years but their share prices have not increased all that much. Despite attractive valuations, we don’t see gold stocks as immune from the coming liquidity panic. If we are right, then gold stocks will be cheap as dirt and warrant buying hand over fist.
I have expected a rebirth of the gold mining industry for 2.5 years. Quantitative easing has grossly distorted markets and delayed this outcome for a year. The coming liquidity panic will be severe, but will also return markets to their proper alignment.
Vedant ‘VK’ Mimani is the lead portfolio manager for the Atyant Capital Global Opportunities Fund, a macro hedge fund in Boca Raton, Florida focused on precious metals.
Gold is good, but gold mining is better