Can The 2008 30% Drop In Gold Price Happen Again?

by: Doug Eberhardt

- Fear is subsiding, and gold follows fear.

- Dollar and gold- we're not at extremes yet.

- A cautious word on gold mining stocks.

The DOW and Gold

Many don't remember in 2008 the 30% drop in the price of gold SPDR Gold Trust ETF (GLD) that coincided with the drop in the stock market represented by the Dow Jones Industrial Average (DJIA) which lost 34% the same year. They do remember gold bottoming in November 2008 and taking off to its all-time high in 2011 putting square blame on the financial bubble that had just popped and an uncertain future. It took until March of 2009 for the DJIA to bottom at 6,594.44 before climbing to over 18,000 by 2015.

This rise in the stock market received some fuel from the beginning in December 2008 3 months before the DJIA low with the first round of quantitative easing (QE1) and the beginning of the "wealth effect" which then Fed Chairman Ben Bernanke alluded to in 2010 when he said the following;
Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
We then got QE2, QE3 and a stock market that moved higher until March 2, 2015 when the DJIA hit a closing high 18,288.63. Gold peaked in 2011 after QE 2 and before QE 3. The stock market was taking over again as the asset to own and with the dollar rise, gold became an afterthought.

The Fed stopped its asset-purchase program which added $1.66 trillion to its balance sheet bringing it from $898 billion in August of 2008 to $4.49 trillion the date it stopped QE and today sits at $4.83 trillion. Just 4 months after the Fed stopped QE, the stock market peaked, but gold still remained weak.

Once the Fed ended QE the talk became centered on when the Fed would begin to raise rates.

Month after month we waited for the Fed to give the green light that a rate increase would signal that all is well in the economy. CNBC financial commentator Melissa Lee even went so far as to say the Fed "chickened out" after failure of the Fed to raise rates during the September 2015 Fed meeting.

The Fed finally listened to Lee and raised rates in December 2015 as they thought the economy was ready with the U-3 unemployment rate falling to 4.9%, ignoring the fact that the real unemployment figure of U-6 actually rose to 9.9%. They not only raised rates 1/4% but indicated there would be 4 more quarter point increases in 2016. But 2016 started off with the worst beginning to the stock market ever where most rallies were sold forcing some at the Fed to indicate there may not be as many rate increases even though Yellen's Fed said rate hikes are still coming but would be "gradual."

No discussion of when those hikes would come but St. Louis Fed's Bullard says it'd be "unwise" to continue rate hikes stating;
I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations.
But what many are not discussing is what the Fed said in that January Fed meeting relating to global implications. The FOMC said it is "closely monitoring global and financial developments."

After watching the movie The Big Short (or reading the book by Michael Lewis) one can come to the conclusion that the big banks got themselves into trouble, got taxpayers to help bail themselves out, fixed their balance sheets with the help of the Fed and are now doing just fine again handing out bonuses pay raises to their CEO's. That may be true for now in the United States, but it is not true in Europe, Japan and China. The next big short can come from any one of these countries just as the Asian financial crisis was started by countries devaluing their currency leading eventually to a U.S. mini crash for the DJIA by October of that year.

While the Great Chicago Fire was started by a cow in 1871 that burned the entire city down (it's actually debatable) the next financial crisis, and we all know one will come, doesn't have to start on our shores and the Fed understands this. I go into detail with this European, Japanese and China connection in my next book Illusions of Wealth but the following analysis from the book I think is important for you to understand now relating to just Europe's banks.

As of January 2016, The world's oldest bank Monte dei Paschi dropped 34% in January alone.

Europe's 46-member Stoxx 600 Banks Index is at the lowest level since 2012.

But if you were to ask a European banker in 2014 and again in 2015 their outlook for all business lines, it was as rosy as can be. If you watched The Big Short you'll also recall those in banking having no fear about the futures.

"Every fractional reserve bank depends for its very existence on persuading the public-specifically its clients-that all is well and that it will be able to redeem its notes or deposits whenever the clients demand. Since this is palpably not the case, the continuance of confidence in the banks is something of a psychological marvel." Man, Economy & State (1972) Scholar's Edition (2009). Ludwig von Mises Institute, Auburn, Alabama 36832 P. 1009, 1010

Negative Rates

With the interconnectivity of banks in the world today you can see why the Fed is worried about global ramifications. Is it any wonder that the Office of the Comptroller of the Currency is also proposing that U.S. banks with assets more than $50 billion show stress survival plans in the event of another severe financial crisis? If things are so great with the economy and higher rates are on their way, why does the Fed want to test how banks would handle negative rates?

Meanwhile the 10 Year Treasury rate has fallen from 2.043% the date of the last Fed's meeting in January to 1.75% today.

Are we on our way to negative rates? Some like Carmen M. Reinhart, Minos A. Zombanakis Professor of the International Financial System at Harvard University, say we. Believe it or not, we've been here before and perhaps we'll see gold bottom before this were to occur because the Fed is always late with their policy as we learned with the last crisis. First though, let's see how the European situation unfolds before we see if the U.S. is next as the LA Times just asked in a recent article; Some countries are using negative interest rates to fight slowdowns: Is the U.S. next?

Real short-term interest rates since 1870

The Vix Volatility Index and Gold

During the first month of 2016 and most of February, the volatility index Vix Volatility Index (VIX) soared. Gold also soared. I had written in my April 3, 2015 article the missing ingredient for gold to move higher was "fear." I had first brought up the VIX in my 8 indicators article when gold was 1283, when it was 27.91 and by April 3rd it had fallen to 14.37 with gold at $1,200 an ounce. Today we have the VIX at 20.53 after hitting a high on Feb. 11th when gold hit its closing high of $1,241 and yet gold is still at $1,231.15. This tells me gold is overpriced at present and would have the propensity to fall.

Dollar and Gold

When one pulls out and looks at the big picture for gold and the dollar as the next chart does, you can see the extremes over the last 4 decades represented by the purple lines. They are all approximately the same length and show the difference at the peaks and low marks where gold and the dollar are at complete opposites on the chart. But you don't see too huge a difference here in 2016 which leads this author to conclude that the dollar should move higher and gold lower in 2016 but I think it can be a fast washout move for gold that I have been patiently waiting for.

To get this outcome we need the dollar north of 100 to a possible target area of 120. Gold could fall 30% if this were to occur putting it just south of my $900 target where I plan to write my "all in" article. I'll give my reasoning for writing it at that price, assuming everything I see coming occurs. I will say though that if gold is falling hard along with most other assets when there is the deflationary contraction similar to 2008, the devastation can more painful that people think but gold will once again be leading the charge out of the carnage to new all-time highs as it did through 2011. Oil as you can see from the chart below had a similar outcome and I see lower prices for oil in the near future too, continuing its decline after this current run up in price concludes.

To make the case for a strong dollar, and I have been correct predicting it since 2011 I need to provide good reasoning to readers and I'll explain that hypothesis more in my next article.

A Cautious Word On Gold Mining Stocks

For those following the gold miners higher like the Market Vectors Gold Miners ETF (GDX), Direxion Daily Gold Miners Index Bull 3x Shares ETF (NUGT), Direxion Daily Junior Gold Miners Index Bull 3x Shares ETF (JNUG) we still have them green on the weekly and monthly with my ETF Leveraged Trading Service since the beginning of February. But I feel a turn is coming with Direxion Daily Gold Miners Index Bear 3x Shares ETF (DUST) and Direxion Daily Junior Gold Miners Index Bear 3x Shares ETF (JDST) soon to taking center stage.


I've given you analysis on 3 areas that I watch to decipher what happens next in gold. I should have come out with an article when the VIX started to move higher but was busy writing my next book and as I did last week, apologize. If you have ever written a book before, and as a perfectionist, you may know it's not the easiest thing to do. But after all this analysis I have done my conclusions on the lower price for gold still stands and now you are equipped with this reasoning to either wait on future purchases or just say you don't care and your mind is already made up and you want gold as insurance. My best advice remains to dollar cost average into your allocation that you want for gold and take some of the guessing out of the equation.

We know a crisis is coming and hopefully my timing for the all-in article is good. The bottom line is if you don't have any gold, get some and if you do possess gold, chances are you'll love to buy more if the price were to fall.

While I am a believer in physical gold, I am ok with traders profiting short term in ETFs like the SPDR Gold Trust ETF (NYSEARCA:GLD) or for silver the iShares Silver Trust ETF (SLV). But you may want to in the near future protect your gold holdings by looking at an ETN like the DB Gold Short ETN (DGZ) which shorts gold.

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