Is It Time to Buy Gold?

Just a few months ago, the race was on for gold. In March, gold blew past $1,000 an ounce. Commentators were jumping over each other to make a more attention-getting prediction than anyone else was.

$1,500 an ounce…$2,000…$3,000 – they would say.

The gold bulls were getting very aggressive. Some even started adding a time element to their predictions (i.e. “gold will hit $1,500 an ounce within a year” – that really only happens when bullishness is at an extreme high). I’ve even saw a few - back of the envelope - calculations to justify $10,000 an ounce gold…or higher!

At the time, inflation was a top concern, Wall Street was turning to precious metals in a big way, and gold stocks were setting new highs for the decade.

It was euphoric. Even shares of Seabridge Gold (NYSE:SA) – which just owns a lot of property with gold in the ground – were being bid up every day. The company, which has no sales or revenue, was worth more than $1 billion.

With China’s inflation rate at 12%, Vietnam’s at 20%, Russia’s at 8%, and every other emerging economy facing rampant inflation, the future seemed very bright for gold and precious metals. Expectations of future riches in precious metals were growing stronger by the day. And many gold bugs were eagerly anticipating the big payday that some have been waiting on for 30 years. It was finally going to be “their time.”

Needless to say, it was a very exciting time to be a gold investor. Exciting investments, however, rarely turn out to be all that exciting in the end.

Here we are six months later. Gold price is down 20%, silver prices have been cut in half, and gold investors were met with the financial catastrophe they’ve been waiting for. Stock markets around the world went into freefall, banks failed, real estate values spiraled downward, consumers decided to start saving (all at the same time, practically)…a true financial crisis was at hand.

Gold, as a safe haven, would surely soar, right?

Well…it didn’t, and it probably won’t for a while. Here’s why:

Where, Oh Where, Has My Inflation Gone?

Gold has traditionally provided protection against inflation. I’m sure you’ve heard them all, including: gold is a store of value; gold has been a means of exchange for 3,000 years, etc. Gold has many attributes, which make it attractive.

Of course, detractors can make a decent case against gold. Warren Buffett probably summed the case against gold best when back in 1998 he said:

[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

At the Prosperity Dispatch, we go as far to say gold is not an investment (it’s one of the most commonly misunderstood market myths). Gold is, however, an insurance policy against hyperinflation or economic catastrophe.

But with gold nearing $800 an ounce, is now the time to be buying gold?

Don’t Worry, Be Happy

The answer is yes and no. If you look at gold as an insurance policy and you don’t own any gold, then the answer is yes. However, if you already have gold, then the answer is a bit more complicated.

At its root, inflation is based on the amount of money supply. If there were more paper currencies floating around in the world chasing the same amount of stuff, then naturally things would get more expensive. That’s inflation. But right now, we’re in a period of deflation. Things are a lot cheaper than they were just a few months ago, and everything is getting a lot cheaper.

Just look at the prices for commodities. Zinc and nickel prices are off more than 75%. Copper, aluminum, and iron ore prices are down more than 50%. Fertilizer prices have practically fallen off a cliff. Oil, natural gas…you get the picture.

Deflation is not just in the markets though, you can see it all over in the real world. As we’ve been anticipating for a while, retailers are slashing the price on anything (You can view the original article on how bad the retail downturn will get here.), and they’re only going to keep slashing prices. From their perspective when cash flows are drying up and the bills are piling up, it’s far better to sell a sweater at a loss than have it unsold.

It’s not just prices at the mall though. Gasoline prices have fallen for 77 straight days. The automakers are sponsoring massive discounts (as big as 50% off in some places) just to get their bloated inventories trimmed down. Pretty soon you’ll see the impact of falling oil and energy prices in the form of lower electricity and heating bills.

If anyone who is concerned about inflation now, they simply shouldn’t be. As Jeremy Grantham noted a few weeks ago,

Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!

Printing Presses on Hyperspeed

However, I know why many gold buyers are getting frustrated, as they are constantly barraged about how much new fiat currency is being created.

The Fed is printing dollars at an unprecedented rate, and if the economy doesn’t turn around in the next year or so, the U.S. central bank could be on the hook for trillions more. The only way it can pay for it is with more new dollars.

Therefore, it would make sense, on the surface, that inflation is imminent. Frankly, the risk of inflation down the road will be very real (remember, the Fed can reduce money supply as well). For now though, consumers are dealing with one of the greatest periods of paper wealth destruction of the past century.

Real estate prices have tumbled and still haven’t hit rock bottom. On top of that, the overall stock market has been cut in half. That means about $20 trillion in wealth has been eliminated.

Sure, that was all paper wealth and it was never real money that anyone could spend. But it sure had an impact on consumption. The average consumer who watched his house triple in value over the past few years certainly splurged on a few nice things. And the man whose portfolio just doubled certainly spent a few extra bucks on whatever he wanted when the market was setting new highs.

That’s why despite the trillions of new dollars being thrown into the economy, we’re still in a period of deflation. A lack of inflation will certainly put the brakes on any bull market in gold. That is, if we’re really still in a bull market for gold.

I’ve Never Seen a Bull Market Like This

This is what concerns me most right now about gold. There’s a good chance the bull market may be over. Gold is already down 25% from its March highs and a lot of investors are betting it’s just a correction. I’ve got to tell you, I’ve been through quite a few bull markets and I’ve never seen one like this.

A few months ago, gold shot up $70 an ounce in a day. It was gold’s biggest one-day move in history, but the rally was short-lived. Following the big move, gold prices dropped almost 30% before bottoming out just under $700 an ounce. After all those sharp ups and downs, no one was really surprised when gold would drop $40 in one day and then climb $30 the next, and vice versa.

This is what concerns me, because bull markets are usually much steadier. There’s some volatility, but ups and downs are usually pretty small.

The perfect example is the bull market in fertilizer stocks. For years, stocks like Potash Corp (POT) and Mosaic (MOS) would just steadily climb. Then over the summer, all of the fertilizer stocks doubled in price in about two months time. The bubble started to form and it looked like these stocks would go on forever.

Then in July, fertilizer stocks became precariously volatile. I was watching Mosaic closely (because I had a sizable short position on it), and remember it dropped 20%, rebounded quickly, dropped sharply, and rebounded again, all in a few weeks time. The bull market in fertilizer stock was showing it wasn’t bulletproof after all.

Whether gold goes up or down will depend on many factors. However, with gold at $770 an ounce and as volatile as ever, it’s definitely not a “sure thing” from here.

Investing and trading is in essence a game of risk and reward -.buy low/sell high. The risks of gold falling further are very real. Deflation is the top concern and the price of everything is falling, and gold is not immune.

To win big safely, you have to buy low. Buying low reduces your downside and increases your upside. It’s the only way to get the risk/reward potential in your favor (step one to making a successful investment).

With that in mind, when asked, “Should I be buying gold right now?” The answer, for most of us, is no. Gold, at $770 an ounce, is at a midpoint, and if you’re looking to buy gold, chances are you’ll be able to pick it up a good bit cheaper than you can today.

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