March 6, 2007 – Here’s an update regarding gold. I believe the big drop in gold prices that we saw last Friday was largely due in part to speculators at hedge funds that were forced to cover their positions in an appreciating yen (which they use to leverage their hedge funds) and in a weakening global stock market. Due to the pronounced effect of risk in hedge funds created by heavily leveraged assets, hedge funds exit huge speculative positions in mass at times when their leveraged positions work against them as opposed to working for them (as was the case when the yen appreciated and emerging markets tanked).
Last week, I mentioned that the gold markets and gold stocks were merely being dragged down as a consequence of these corrections and not due to an inherent flaw in gold as an investment. Furthermore, I stated that prolonged weakness in traditional markets would probably manifest itself in the precious metal markets for a while longer due to the interplay among precious metals, hedge funds and emerging markets, though logic says the opposite should be true- that a flight from traditional equity markets should benefit the markets for gold and gold stocks.
Hence, the new financial world order. Due to the unregulated nature of hedge funds, there is now much more instability and volatility in our markets then there should be given the irrational, immediate-gratification driven decision-making of many hedge fund managers. The way hedge fund managers are compensated encourages them to chase whatever is the “hot” asset and to dump it at the first sign of weakness even when the long-term fundamental picture is quite good. Note that this is the reason I say that hedge funds hold “speculative” positions in gold stocks- it is speculation on their part because they never look to hold through dips and corrections and at the first sign of weakness dump everything they have and look to move on to the next “hot” asset.
The enhanced volatility created by this behavior in turn forces many investors that want to hold on through the dips to liquidate as well, which then has a domino effect. Of course, we know that the market is full of millions of irrational investors to begin with. Hedge funds have only multiplied the irrational level of behavior that exists in the global markets today. However, the fundamental risk-reward scenario that surrounds the precious metal asset class makes it far from being a speculative asset class. In fact there are many inevitable events that will cause strengthening in this asset class.
So as I mentioned last week, the silver lining in the cloud of irrationality and increased volatility is that it creates buying opportunities for latecomers whereas buying opportunities such as this one we are currently experiencing should really not exist (at least to this great of a degree). To those savvy investors that have entered significant positions in gold and gold stocks well before the masses, this increased volatility serves as nothing more than a major nuisance and annoyance, but certainly should not compel the informed investor to panic and fully sell out of his or her positions, though paring back positions seems to be wise at this juncture to protect profits.
So the big question for many gold investors is what do I do if I have already loaded up on gold stocks? If this is the case, the last week has been somewhat painful for us, but again, let me make this point clear — the increase volatility in gold has been amplified by speculators that are being forced to close out long positions in gold futures as the appreciation of the yen is squeezing their margins and by those that were forced to sell out of greatly appreciated gold positions to cover their losses in the traditional markets, developed and emerging. This is not to say that this correction would not have come if emerging markets had not corrected and the yen had not appreciated to three-month-highs against the dollar.
The one thing we can be assured of in the future is that when gold resumes it rise again, we will again be subjected to scary sharp steep declines in the price of this rare earth metal and its associated stocks. These corrections happen like clockwork so we will see others throughout the course of this gold Bull Run. However, the consistent fault among many investors is to believe that this sharp decrease in gold is being brought about by the correction in the global equity markets.
Last week, I marveled, given the next day recovery in the U.S. markets that followed the beginning of this onslaught, how many financial reports all across the U.S. reported the expert opinions of many that the downturn in the U.S. markets was a one-day wonder and that the bull markets would resume after this one-day correction. If you go back and check archived news in the U.S. financial media you will actually find stories of financial journalists who wrote about the correction in the U.S. markets being a one-day event. I noted that this was foolish and that sustained weakness was far more likely. However, as I also previously noted, I don’t believe this to be the onset of the Peak Investment Crisis, though one can interpret it as cracks in the dam that give more credibility to our Peak Investment Crisis theory. I believe that the fact the corrections have more staying power than just the one-day wonder is due to inherent fundamental economic weaknesses that are never reported in the mainstream media, and not just solely due to irrational investor panic, though certainly panic is a contributor to this continuing onslaught.
The last two pages of this article are reserved for maalamalama members. If you are a SmartKnolwedgeUâ„¢ member, please check your email for critical, important further information on how to best benefit from this global market correction. For those of you that desire some more free information about the proper way to play gold stocks, please visit one of my previous blogs, The Real Deal About Gold & Energy, dated January 11th, 2007 by clicking on this link.
[tags]gold, how to invest in gold[/tags]
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J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.
