COULD GOLD FALL SHARPLY? / MACLEOD FINANCE

Could gold fall sharply?

The purpose of this article is to examine whether this can happen, and if so under what conditions.

ALASDAIR MACLEOD

One of my paid subscribers sent me the following message:

“Hi Alasdair. Some pundits (such as Henrik Zeberg) are forecasting a market melt-up (e.g., S&P 500 steadily approaching the 7,000 level) in the next three to eight months, to be followed by a massive market correction of 50 percent or more due to overvaluation. 

In this environment, Zeberg and others are predicting that the dollar, in the short term, will rally strongly (perhaps even as high as 140) as investors flee to safety, causing precious metal prices to fall sharply. 

The final stage, according to this theory, is that gold and silver will then begin to rebuild and will move to much higher prices in the not-too-distant future. 

I would love to know whether you agree or disagree with any or all of this thesis.”

This is my response

Clearly, a rally in equities taking the S&P 500 another 12% or so is not impossible given that it is always difficult to predict an equity top, particularly in a credit bubble driven by momentum. 

All we know is that after it bursts, the downside is considerable, likely to be more than the 50% the above-mentioned pundits predict.

As to whether the dollar will rally strongly, that is also not impossible. 

If other currencies face a crisis, the dollar will certainly rally. 

How high depends on the origin and nature of the crisis. 

But it is worth mentioning that the dollar is already over-owned by foreigners, unlike the other major currencies with the notable exception of sterling.

A credit crisis, which is a racing certainty is the key to these expectations. 

The Fed would want to cut interest rates as it usually does to kick the can down the road. 

But how markets react depends on the circumstances, and even then, are not necessarily predictable. 

For now, gold is rising along with long-term bond yields. 

Should they fall, gold could rise even further.

Perhaps the pundits referred to above are harking back to the last credit crisis in 2008—2009, when gold fell initially from $1000 to $680 before continuing on to $1920 in September 2011. 

But the run from $250 in 2002 to $1000 in March 2008 started from a higher, though admittedly not excessive level of speculative long interest in gold, silver, and the mines. 

But in an investment world driven by macroeconomic beliefs, some short selling of gold by hedge funds and others cannot be ruled out.

My conclusions are as follows:

· There will be a major crisis, or multiple ones: history tell us that credit bubbles burst, and there is no doubt that this one is over-ripe — just look at the levels of government and zombie debt, and the excessive valuation of equities relative to debt. 

Furthermore, today’s echo of 1929, which followed the roaring twenties, has its own version of Smoot-Hawley tariffs, a combination which led US equities to collapse 90% top to bottom in 1932 and the closure of 9,000 banks.

· Governments are in debt traps, which will be exposed more clearly as private sector GDP is acknowledged to be contracting. 

Governments cannot, or will not cut their spending, and their tax revenues are falling short, making their debt unsustainable, typically at 100% of GDP or even more. 

Whatever might be engineered in the short-term, debt yields will rise significantly to reflect default and currency devaluation risk.

· Lastly, expect extreme volatility in credit markets. 

Trade them at your peril. 

Wise investors will simply get out and stay out of credit, which can only be done by hoarding gold and silver. 

Buy on the dips, but don’t sell on their expectation!