Gold’s “Contrarian Moment”

By David Galland, Casey Research

Glancing at the news most days, it’s hard not to feel like Bill Murray’s character in Groundhog Day. In the event you are unfamiliar with the movie, in it Murray’s character becomes trapped in the same day… day after day.

In the current circular condition, we have the powers-that-be assuring us that the next high-level meeting will finally produce a permanent fix to the broken economy, essentially solving the sovereign debt crisis. Then, in no more than a few days, or at most a couple of weeks, the fix is revealed to be flawed and the crisis again sparks into flames… followed shortly thereafter by yet another high-level meeting – and the cycle begins anew.

While the characters may change – one week it is Greece, the next it is Spain, the next it is France, the next it is the US, the next it is Greece again, etc., etc. ad nauseam – the detached observer can only come to the conclusion that we are now well outside of the bounds of the normal business cycle.

As we at Casey Research have written on this topic at great length, I don’t intend to dwell on this topic, but I did want to loop back in just long enough to comment on the recent price action in commodities, especially gold, in the face of the continuing crisis.

Today, a glance at the screen reveals that gold is trading for $1,565. For comparative purposes, as revelers warmed up their vocal cords to sing in the New Year on the last trading day of 2011, gold exchanged hands at $1,531. And exactly one year ago to the day, gold traded at $1,526 for a one-year gain of a modest 2.6%.

A year ago, the S&P 500 traded at 1,325, while today it trades at 1,318, a small loss. Yet, have you noticed we don’t hear much about the imminent collapse of the US stock market, as we do about gold? This perma-bear sentiment about gold on the part of what some people lump together under the label “Wall Street” is especially apparent in the gold stocks.

Using the GDX ETF as a proxy for the sector, we see that the shares of the more substantial gold producers are off by an unpleasant 24% over the last year.With that “baseline” in place, let’s turn to the current outlook for gold, and touch on some of the other commodities as well.

• Gold.In the context of its secular bull market, and given that absolutely nothing has gotten better about the sovereign debt crisis – only worse – gold’s correction is nothing to be concerned about.I know the technical types will point to levels such as $1,500 as important resistance points – and there’s no question that if gold was to break decisively below that level that a lot of autopilot trades would kick in and put further pressure on gold.Yet, when you view the market through the lens of hard realities, which is to say, by focusing on the intractable mess the sovereigns have gotten the world into… in Europe, in Japan, in China and here in the US… then viewing gold at these levels as anything other than an opportunity is a mistake.
• Gold Stocks.As far as the gold stocks are concerned, I consider today’s levels to be extraordinarily compelling for anyone looking to build up a portfolio or to average down an existing portfolio.I say this for a number of reasons, starting with the contrarian perspective that this may now be the most unloved sector of the stock market. No one wants anything to do with gold stocks, and hasn’t for some time now. As a consequence, the sellers will soon dry up, leaving almost nothing but buyers to push the sector back to the upside.This contrarian perspective is important because finding an honest-to-goodness opportunity to bet against the crowd is no easy thing in a world where literally thousands of competent equities analysts plop down at the desk each trading day with the sole purpose of searching for prospective investments. Many of these analysts are backed by huge firms with billions of dollars at risk in the markets, and so are armed with high-powered computational tools of the sort that was unimaginable even a few years ago. All of these analysts, armed with all their computational power, habitually scan a universe that totals about 4,000 publicly traded companies. Realistically, however, even a thin analytical screen will weed out all but perhaps 400 of those companies as being potentially suitable for investment.Thus, you have thousands of high-priced and well-armed securities analysts crunching pretty much the same data on a very small universe of possible investments. Given this reality, is it any surprise that securities are so tightly correlated? Which is to say, is it any surprise that these securities all trade right in line with the valuations that the analytical screens ultimately derive that they should? Which means there are really only two possible circumstances under which any of these stocks move up, or move down, by any significant degree

1. Broad market movements.The saturated levels of analysis mean that, within a fairly tight range, all the stocks now move more or less together. Thus, with few exceptions, a big upswing or downswing in the broader market will send almost all stocks up or down together. To help make the point, I randomly pulled a chart of IBM and compared it against SPY (the S&P 500 tracking ETF) for the last year. Note the lockstep price movements:OK, IBM is a big company, so it will have a lower beta than many companies, but the point remains that saturated coverage of the stocks greatly reduces the odds of any one issue breaking free from the larger herd, unless there is…
2. A surprise.All of these analysts, and all of their computerized analysis, help form a certain future price expectation for each security based on past financial metrics (earnings growth, return on equity, and so forth). Other than the broad market movement just referenced, or moves in line with a sub-sector of the larger market (e.g., if oil rises or falls, oil-sector stocks will tend to move up or down in sync), for a company to deviate in any substantial way from analyst expectations, by definition requires a “surprise” to occur.Of course, such a surprise can be positive, but because these companies are so closely watched, it is more likely to be negative. In the former category, a positive surprise might come in the form of an unexpectedly strong new product launch á la the iPad. In the latter, less happy category of surprise, it can be the blow-out of a big well in the Gulf of Mexico… or any one of a million other unanticipated vagaries of fate.