How to Play the ‘Ultimate Asset Bubble’

Since the Federal Reserve announced a much-anticipated third round of monetary easing known as QE III, financial markets simply have not responded the way investors may have expected. Stocks and commodities rose during previous quantitative-easing rounds, while the U.S. dollar and Treasury-bond prices declined.

During QE I for example, the S&P 500 rose 50.8 percent and the broader CRB Commodity Index soared 27.9 percent on the belief that massive money-printing would inflate new asset price bubbles.

Meanwhile, the 10-year U.S. Treasury note dropped 5.3 percent and the dollar slid 6.4 percent.

During QE II, investors witnessed a similar, but more-muted response. Stocks rose 26 percent and commodities rose 26.5 percent while Treasury bonds slipped 3 percent.

But since QE III was announced on September 13, 2012, the results look quite different so far.

• The S&P 500 Index is DOWN 3.4 percent …
• 10-year U.S. Treasury notes are UP 1.5 percent …
• And the CRB Commodity Index has slipped 7.3 percent.

Even gold, which legendary hedge fund manager George Soros has called “the ultimate asset bubble,” is down 1.3 percent since QE III was launched nearly three months ago.

But people are still buying. Some in big amounts.

Soros and other smart money managers have been adding to their gold hoard lately, doubling-down as the price of gold remains 11 percent below its peak level back in 2011.

Soros Fund Management increased its holdings in the SPDR Gold Trust ETF (GLD) by 49 percent in the third quarter of this year, according to Bloomberg News.

He’s not alone.

Hedge-fund manager John Paulson, who rose to prominence while making his investors a fortune with bets against subprime mortgages during the credit crisis, has also been a buyer of gold using ETFs.

Paulson’s hedge funds own 21.8 million shares of GLD, making him the ETF’s single-largest shareholder. He boosted holdings by 26 percent during the second quarter, before QE III was announced.

Of course there are multiple Exchange-Traded Products (including both funds and notes) besides GLD that have surged in popularity along with gold prices and that give investors a convenient alternative to buying gold bullion or futures.

Investors have purchased 247.5 metric tons of gold through various ETPs so far this year, and total holdings of all ETPs hit a record 2,604 tons valued at $144.9 billion! That’s more than the official reserves of every nation except the U.S. and Germany.

Still there are plenty of gold bears who point to a slowing global economy as one reason why deflationary forces could undermine the price of the yellow metal.

In fact, worldwide demand for gold fell 11 percent in the third quarter overall as both China and India cut back on gold purchases.

Also futures traders still maintain large net-long positions in gold, which from a contrarian’s viewpoint is a potential negative for higher prices in the short run.

With sentiment mixed, it’s more important than ever to focus on the trend in gold, and gold-backed ETFs. The chart below shows the price action in GLD since the beginning of 2012.

Click the chart for a larger view.

After GLD broke out to the upside in August, ahead of QE III, the ETF reached a peak of $174.07 on October 4, up 14.5 percent from the May low.

Since then, GLD has been in a correction, along with most other assets. So far, it has been an orderly pullback of just 4.3 percent, much less than the decline in other commodities or the stock market.

Where gold and GLD goes from here should hold the key to the intermediate-term trend.

You can see key support highlighted (green line) in the $162 area that lines up with the November low. Meanwhile, the October 4 high marks upside resistance for GLD (red line).

A decisive break above or below one of these key levels should determine the trend, whether the bullish breakout continues to the upside … or recent strength proves to be a bearish fake-out, with prices reversing lower instead.

If you’re a gold bull like Soros and Paulson, you may want to consider buying the SPDR Gold Trust ETF (GLD) as it approaches key support, and set a tight stop below that level to help protect your downside.

But if you are bearish on gold prices, you may want to consider an inverse-ETF designed to produce the opposite return of gold prices. The DB Gold Short ETN (DGZ) is one of several that are readily available with good liquidity.

Good investing,

Mike Burnick