Friday, December 21, 2012

Pascometer: Contrarian Indicator Rings "Buy Gold"

Those who have been reading this blog for awhile would know that articles mentioning Gold from Michael Pascoe (Gold aways discussed in a negative light with "gold bugs" mocked) often rings a bell for the bottom of price corrections. He is an excellent contrarian indicator, see this chart from an earlier post:

His negative posts on Gold marking the bottom of corrections led to the creation of the Pascoe Indicator or Pascometer meme (if Michael Pascoe says something, the opposite is likely to occur).

In Pascoe's latest bearish post on Gold he suggests to sell it in order to buy base metals:
Sell gold, buy base metals at the End of Fear

In case you missed it, 2012 is finishing as a dud year for gold. And according to RBS Morgans economist and analyst Michael Knox, 2013 is going to be worse as we enter the “World at the End of Fear”.

After this week’s dip, gold in Australian dollars is up just 2.17 per cent since January 1 – below the inflation rate. Over 52 weeks, gold is actually down 3.13 per cent. Even in US dollars it’s been poor – ahead only 0.67 per cent.

But that’s just taking a cheap (yet irresistible) shot at the gold bugs as such random calendar points as 12 months don’t mean much. Pick another set of dates and you can engineer another outcome. Much more important for all investors is the big forecast sent out to clients by Knox last Friday, before gold took at tumble to a four-month low and iron ore prices continued to firm.

Despite various on-going headlines, Knox argues that we’re entering the end of fear, that financial markets in 2013 will see their lowest volatility since 2006.

In brief, after two international banking crises in five years, we’re getting over the fear that there’s another one around the corner. With central banks pumping out liquidity, keeping interest rates down, lower volatility and less fear will mean investors will have less demand for “precautionary assets”, those  that are held out of fear, “just in case”: gold and US treasuries.
So based on his suggestions we can expect 2013 to bring a large increase in the price of Gold and a lot more volatility as the market complacency breaks down? I suspect this will be the case, but obviously not only due to the Pascometer meme.

It's interesting that a very similar conversation took place in the comments section of Macro Business only hours before Pascoe's piece on Gold and fear... coincidence?

Peter Fraser had the following to say:
I’m less optimistic for gold BB. I see buying gold as a fear play, with concerns about hyperinflation and the collapse of fiat currencies. Now that the market can see that hyperinflation is not a current threat and fiats won’t collapse, with the USA economy getting stronger, fear has subsided. I think the driver for gold at the moment is fear.
To which I replied:
I do think fear has played a part in Gold’s rise, there have been short term periods where this has been especially noticeable e.g. when the USD and Gold rose together during the worst (so far) of the Euro-crisis. But I don’t think fear is the only driver, for example demand from central banks buying is a new driver added to the market in the past few years (where earlier in the decade they were net sellers). Only last night we had news of Brazil doubling their Gold reserves:

Also I think it’s preemptive to suggest that the fear should have subsided over currency debasement, especially given the strong words out of Japan a few days ago:

And the recent announcement by the Fed that they would increase their bond buying.

That’s not to suggest hyperinflation is around the corner (in fact I think we would see changes to the monetary system before that was allowed to occur in the US), but I think the environment which Gold has thrived in for the last few years is set to continue, namely one of negative real interest rates, irresponsible fiscal policy and debasement of currencies. So expect a higher Gold price in the near future, but as I said above “Time will tell”
And another user cangaceiro99 followed up with:
Just to add to what BB has already touched on, where interest rates are low, the opportunity cost of holding gold is low also.
Given that the amount of sovereign debt is so large that a rise in interest rates would make sovereign debt unserviceable for many countries (relative to their tax income), I think you will continue to see govt central banks try to maintain this “co-ordinated” policy of low or negative real interest rates indefinitely.

As to central banks buying gold, perhaps they are copying the Europeans, where in 2000 they had perhaps 1/3 of the euro backed by gold and 2/3 by foreign reserve currency holdings. 12 years later, gold now makes up 2/3 of their holdings (based purely on valuation changes, not volume) and foreign reserve currencies 1/3.

I’m not confident will see hyperinflation in the future, I think the world is too interconnect for this to occur over a prolonged period, so I would concur with BB, a quick reset at some point is more likely.

The thing that confuses me about fiat is that given the USD (the world’s reserve currency) is borrowed into existence at interest, unless they keep creating more money, there is not enough money that exists to pay the interest on the existing money that has been created.

So despite talk of deflation, money printing must continue, for the system as we know it to continue.

As there is so much money around, interest rates must be kept low to service the debt. Once the interest rates spike, the debt becomes unserviceable.
That bolded text really is the bottom line.

Growth is currently being generated by increasing levels of public debt as private household debt stagnates or is falling. This debt shuffling doesn't solve the underlying issue (a massive debt bubble formed over the past several decades). Until we see real change to the burden this debt presents, through massive inflation, a debt jubilee, global defaults or some other reset or reduction, I don't see the crisis as resolved. Gold will continue to perform well in the face of continued efforts to paper over the problem and may perform even better in the case that it is used in the final monetary solution (e.g. as discussed in my recent post on Freegold).

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