The Gold Short

Historical highs are very tempting buy points. Can this best time for Gold bulls be the worst entry point?
If you ask market players to compare physical gold and simple arithmetical relative performance, what do you think investors would choose? Yes, definitely gold. When it comes to gold, we can short all sanity and go long all owning gold. The very fact that the society is so long on irrationality is the reason that time cyclicality works. Markets move from one extreme to the other and it is between these two extremes that the society pauses, gets into excitement lows, becomes conservatives, talks about value, lays down new foundations and structures, talks about ethics and corporate governance, gets debt smart etc. This pause is also known as rationality.
Gold is a part of the global asset complex that moves with market mood. Market players see the rising and falling, but the society can’t calculate relative performance. How much did my gold portfolio deliver compared to the rest of the market from the start of the year? A very basic question to secular gold bulls who never stop believing in gold. How much did gold rise from Mar 2009 compared to the dollar? Should gold bulls worry about dollar strengthening? How much did gold deliver in a currency other than the dollar?
Gold underperformed S&P 500 from Mar 2009 by 14%. This means gold bulls would have done 14% better by holding just the S&P 500 and not gold. How do the gold bulls know that the next 6 months are going to be any better for gold? Well, there is a probability that that gold bulls might not know. Gold generally moves against the dollar. A dollar strengthening is accompanied by a weakness in gold and vice versa. However, traditional relations fail at times like they did from the start of 2010. Both gold and dollar rose. This means if you were holding a gold portfolio in a currency other than gold, year to date gold delivered on average 4% more than S&P 500. This is marginal when we compare it to the gung-ho surrounding gold.
Behavioral finance clearly highlights that investors diversify less. Diversification is also suggested as an action point to reduce risk. Investor inability to look at gold relatively to other assets including dollar (denominated currency) clearly highlights investor inability to comprehend a macro portfolio of global assets. Investors are so regional in their outlook or so focused on a few assets that they don’t realize the foregone opportunity cost and other macro adjustments. Other aspect locals miss but foreigners understand is the forex risk. If one converted euros into dollars and invests in US stocks, year to date that portfolio delivered 10% with a marginal change on S&P500.
Investors are so focused on historical highs that tread extrapolation becomes intuitive, irrationality looks normal. The view sans relative value turns out to costly over the longer term. Gold is moving up exponentially and has been rising for a record 10 years without a retracement more than 38.2%. The metal has not witnessed a fall bigger than 9 months in time. Technical indicators are non-confirming and suggest weakness rather than strength.
Gold is not in a solo negative run. All of copper, Platinum, Silver, and Aluminum structures look weak and many global metal indices still seem negative. Above this, we have Oil which after struggling at 80 has pushed lower. We continue to look at the retest of 70 and a move down till 60 on Oil. The Reuters CRB index also seems to have further downside left.
The long silver – short platinum pair we mentioned last time delivered 10% since 22 Feb 2010. Long Industrials index – short Nickel is up 4% since 19 May, long precious metals short Nickel delivered 47% since 16 Apr. A more than 10% divergence between two different metal groups indicates market inefficiency and why understanding relative performance could be profitable. Performance reverses polarity, the reason top ranking countries get kicked out from the top 16. It’s time for underperforming copper to reverse polarity. A long copper, a short gold pair should deliver along with long precious metals index (AIGP) and Short Gold.
If all this case of short negativity was not enough on Gold, we have performance cycles on the metals complex. Gold has a topping performance cycle and the yellow metal is top in the ranking of 10 metals. Just like Copper, Silver, Nickel took turns to underperform, it’s time for Gold to underperform the rest of the metals. There is no better time to reduce gold in the portfolio, or short it than when it is at the top. Gold should not only relatively underperform the rest of the metals complex but also just might surprise the absolute bulls.