2 More Reasons the Gold Trade Is Dead

The data doesn't support a bullish thesis.

Alex Dumortier
Alex Dumortier, CFA
May 17, 2013 at 10:18AM

Yesterday's stock market drop was a healthy reminder that stocks do, on occasion, go down. This morning U.S. stocks opened higher, with the S&P 500 (SNPINDEX:^GSPC) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) up 0.51% and 0.35%, respectively, at 10:15 a.m. EDT.

Gold: It's game over
For gold bugs, gold's sharp decline this year has been a bit confounding. Not for long, however, as they can always reach up their sleeve and pull out a trump card: The decline is a result of coordinated central-bank action to suppress the price of gold! This is a perfect example of pseudoscientific analysis. When gold prices are rising, the data confirms your bullish thesis for the precious metal. When gold prices are falling, you reject the data as unrepresentative -- it has been corrupted (and, by the way, the reason for which the data is corrupted is unverifiable). In other words, there is no way to falsify a bullish thesis on gold; that's the way pseudoscience operates.

In fact, one does not need to dig all that far to find accumulating evidence that undermines some of the bullish arguments for gold.

First, inflation, or even expectations of inflation, are nowhere to be found. For example, take the breakeven inflation rate, which is an indicator of expected inflation equal to the nominal yield on same-maturity Treasury bonds minus the real yield on same-maturity Treasury Inflation-Protected Securities. The breakeven inflation rate with a 10-year horizon has dropped to 2.24% from a high of 2.6% in March. That's not exactly Weimar.

Inflation's no-show is related to a second, more fundamental point. As macro-trader and blogger Mark Dow recently argued, "there is zero correlation between the Fed [money] printing and the money supply." The money base (i.e., liquidity) has grown dramatically as a result of quantitative easing, but it is banks and shadow banks that create credit. I urge you to read Dow's piece in order to understand the distinction. The fact is that we have not witnessed an uncontrolled explosion in credit due to the Fed's extraordinary policy. (Yes, I'm aware that specific parts of the credit markets are frothy -- ahem, junk bonds -- but I'm talking here at an aggregate level.)

Shareholders of the SPDR Gold Shares (NYSEMKT:GLD) and the iShares Silver Trust (NYSEMKT:SLV) need to carefully consider the hypothesis that the gold trade is dead (the silver trade is based on the same dynamics). I believe it, and so does Mike Novogratz, the co-chief investment officer of the Fortress Macro and Drawbridge Global Macro funds, who told CNBC on Wednesday:

I personally think gold is toast. ... We peaked out at $1,900 two years ago. If you've run the gold chart over the Nasdaq chart over the Nikkei chart in 1989, they're identical. Once bubbles pop they go all the way down. ... Gold was a classic bubble. ... The gold ETF volume just kept picking up, and now it's on the reverse; it wouldn't shock me to see gold back at $500.