If it’s every investor’s goal to buy low and sell high, then why is gold still on almost everyone’s “sell” list?
It’s been difficult to make money in commodities this year, none more so than with the yellow metal, which has tumbled 22.9 percent to $1,292.13 an ounce as of Tuesday’s close.
Aside from a rebound in natural-gas prices early this year and a recent rally in crude oil, there hasn’t been much for commodity bulls to get excited about. Most commodities have headed straight down on fears of slowing global economic growth — corn is down 21.9 percent this year, wheat, 13.9 percent, and industrial metals like copper, 12.4 percent, and aluminum, 12.6 percent.
|Gold is now oversold; pessimism is widespread at an extreme negative level.|
But no asset class has fared worse this year than precious metals. Besides a furious bear market in gold, silver prices have sunk 58.7 percent from a record high.
The giddiness over gold from last year has quickly soured. Wall Street analysts are tripping over themselves to slash price targets on precious metals, with Goldman Sachs saying gold will fall to $1,050 an ounce by the end of next year. Some are even saying the decade-long commodity super-cycle is dead.
So is now the time to play contrarian and be a buyer of precious metals?
While it may not be time to go all-in just yet, gold, silver and, especially, undervalued mining stocks warrant a closer look at today’s bargain prices. Let me explain why.
Commodities are unloved and out of favor with investors. In fact, big institutional investors have thrown in the towel. (See chart above.) According to data from Merrill Lynch, global fund managers are now the most underweight in commodities than they have been at any time since the aftermath of the global financial crisis more than four years ago.
Even though the bearish sentiment in precious metals is rampant, it’s difficult to nail down the intrinsic value of an ounce of gold. Gold doesn’t pay interest or dividends, so traditional valuation yardsticks given to stocks and bonds aren’t easy to apply. In the end, an ounce of gold is worth only what someone else is willing to pay for it.
That’s exactly why measuring investor sentiment is such a valuable tool when it comes to analyzing precious metals. And we have witnessed a truly amazing sentiment swing in gold and silver in a very brief period of time.
Recall that it was only two summers ago when bullish sentiment on gold and silver was sky-high.
Just as gold was about to peak at $1,923.70 per ounce in August 2011, speculative positioning in the gold futures market was at a record high, and the so-called smart money institutional investors held a record net long, as you can see in the chart below.
With 20/20 hindsight, it’s obvious that wasn’t a good time to be going long gold. In fact, the extreme bullish sentiment in gold futures two summers ago was sending a powerful contrarian message that the long-gold trade had become way too crowded. Gold and silver were overbought at the time and vulnerable to a correction.
But this summer, after the price of gold has declined nearly $700 an ounce, we see the exact opposite message as seen in the next graph.
At the end of June, speculators in the gold futures market had reduced their bullish bets dramatically to almost a fully liquidated (neutral) position. Gold is now oversold; pessimism is widespread at an extreme negative level — ditto for silver.
I believe futures speculators are about to be proven wrong again as gold soon finds a bottom and begins to trend higher again. The cure to low gold prices, fundamentally, is low gold prices.
After gold dropped 23 percent in the second quarter, many gold miners large and small found themselves “scrambling to cut costs, sell assets and shore up finances,” according to a recent Wall Street Journal article. New projects are being put on hold or canceled. Old mines are being shut down and expansion plans at existing mines that may have been marginal to begin with are getting shelved.
Recent gold prices just aren’t enough to cover the overall (or all-in) costs at many gold-mining firms. But therein lays the silver lining in the precious metals selloff.
Unlike many businesses in today’s just-in-time information age, miners can’t simply flip a switch to increase or decrease gold and silver production. It takes many years and an enormous amount of capital to get big mining projects off the ground.
While a temporary setback in gold and silver prices makes mining a more costly endeavor and reduces production, the longer-term supply impact can last for years, driving gold and silver prices much higher again.
Ironically, it is some of the same gold- and silver-mining stocks that are experiencing so much pain right now that may realize the biggest price gains when the upturn in precious metals finally arrives.
Consider this final chart below. It takes a look back at what happened after the last major correction in gold and silver prices in 2008.
Gold prices tumbled 29.5 percent from peak to trough, similar in magnitude and duration to the current selloff in gold. Predictably, gold-mining stocks were hit even harder, plunging 65.6 percent during the same time period.
But from that low point late in 2008, spot gold prices surged 259 percent higher, and the Market Vectors Gold Miners ETF (GDX) performed even better — soaring 389 percent.
Of course, history may not repeat, but if it rhymes with past outperformance of gold- and silver-mining shares, it may be the most lucrative asset class.
No one rings a bell for you at market tops or bottoms. You’ve got to do your homework and rely on your own analysis to figure that out. Measuring market sentiment, or the madness of crowds, can provide important clues at key turning points in securities prices.
When sentiment moves from good to bad, to totally bleak, ignore the rampant pessimism and watch for incremental improvement. But one thing’s for sure: I don’t want to get caught up in the overcrowded short trade in precious metals right now.