This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, December 7, 2009

Golden Goose Eggs Rarely Hatch

Lately it seems nearly impossible to turn on the TV or radio without hearing another pitch to buy gold. And why not? After all, it’s the easiest story in the world to sell. In this economic and political climate, everyone has fears and doubts that a good salesman can exploit for profit.

Between the bailouts that have recently caused Washington to speed up the printing presses, the prospects of future policies coming down from Capitol Hill that will lead to only greater spending, and the declining value of the dollar in foreign exchange, it’s pretty hard to be an optimist when it comes to the greenback.

Not to mention that lately gold has been making all kinds of headlines, setting new highs on almost a daily basis. In fact, the price of gold has advanced almost every day for the past two weeks.

But one man’s treasure is still another man’s trash. In other words: The same reasons that gold is being touted lately as a great investment idea for the same reasons we as contrarians intend to avoid it, at least for the time being.

Gold’s recent rally, while remarkable, is not unprecedented. One comparable run occurred in the NASDAQ during March of 2000. Of course, that was right before the tech boom ended and the market came crashing down.

One of the favored lines among gold dealers is that the declining value of the dollar will continue to push gold higher. While that is obviously one trend, history has shown us that it is not always true. Several times, even during the 1980s and ‘90s, both the dollar and gold fell at the same time.

And yet radio and TV are flooded with ads from the likes of Goldline, Lear Capital, et al. People just don’t seem to get it: Those companies running commercials are trying to sell you THEIR gold in exchange for YOUR dollars. What exactly does that tell you about their outlook for the price of gold, much less the dollar?

Right along with those commercials, Aaron Regent, the CEO of Toronto-based Barrick Gold, the largest gold mining company in the world, has been running around lately pushing gold because his company recently unwound the last of its hedges.

What that means is that Barrick is no longer protected from a falling gold price. Of course, if Barrick is really so omniscient, it’s curious that they didn’t unwind those hedges ten years ago, before gold quadrupled in price. Instead, they waited until gold reached all-time highs to start participating.

Mr. Regent has also been peddling the idea that the world currently at peak gold. His argument is that production has been decreasing since 2003, so the world must be running out of gold. How strange, then, that production numbers have lately increased in China, Russia, and Australian in reaction to gold’s increased profitability as of late.

Gold, like any other commodity, responds to supply and demand. Take oil for example, particularly the tar sands in Canada, where oil is drilled on the occasion that it is a sufficiently profitable operation. Production has to be profitable in order for miners, drillers, etc to ramp up production.

Even more disturbing is that the demand for gold recently is not for physical bullion, but paper gold. The world’s largest consumer of physical gold is India, where gold is used extensively in jewelry, especially during wedding season. But Indian brides aren’t exactly scrambling for the yellow metal.

Instead, the vast majority of demand for gold is among traders, and that is for paper gold in the form of futures and options contracts. Speculators (i.e.: traders in the gold market who do not represent miners, refiners, dealers, bullion banks, or central banks) have recently been piling into gold – at least on paper.

On the other side of those contracts, commercial traders (read: smart money, traders representing those companies intimately involved with the precious metals industry) have been amassing record-setting short positions.

It’s understandable why, in today’s climate, people are nervous and want some kind of insurance policy, or even some investment that can help propel their portfolios back to pre-crash levels. However, put plainly, investors ought to know that if they are buying gold, realize that the smart money is lined up against you. Further, know that those traders have the kind of balance sheets required to prove themselves right.

This is neither a test of wills, nor a question of right versus wrong. The gold market is, on a relative basis, extremely small, and its workings understood by a very small group of people. Outsiders would do well to tread very, very lightly, if at all.

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