Is More Pain Ahead for Gold Investors?

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Since the precious metals bubble began almost 10 years ago, the prices of gold and silver have been driven more by fear, greed, and other emotions than by fundamentals or allegedly rational reasons.

Gold pays no dividend and provides no cash flows; it actually costs money to own (storage fees and insurance premiums), and it is used in relatively very few industries compared to other asset classes such as land, housing, equities, bonds, or even timber. You simply can't value precious metals the same way you do other investments.

If most gold (NYSEARCA:XME) isn't owned for sound fundamental reasons, it seems that investors must stop trying to value it in fundamental ways and focus on what really matters when it comes to the precious metals market.

What Really Matters With Precious Metals

There are countless examples of "experts" getting the gold trade wrong as our firm has highlighted numerous times throughout the years; one such example was our article Is the Worst Really Over for Gold and Silver?

All the gold bugs (NYSEARCA:NUGT) who have been touting gold for years based on "fundamental" reasons such as the Fed's non-stop printing press are now getting crushed. They rode the precious metals bubble, falling victim to one of the oldest axioms on Wall Street: "Everyone is a genius in a bull market." If the real reason to own gold is the printing press, then shouldn't the US dollar also be getting hammered?

These experts confused their "correctness" through 2011 with simple correlation of a precious metals market rising because of an entirely different reason: euphoria (which has always driven the gold market).

In 1999, when gold was trading at 30-year lows, no one wanted to touch the precious metal. Contrast that with 2011 when "sell your gold" commercials were on every television channel. Those commercials can still be found.

Even central banks around the world were selling gold at its 30-year price low and buying at its all-time high. As an example of just how clueless central banks (and others) have been when it comes to gold, Ben Bernanke himself said to the Senate Banking Committee in July, "Nobody really understands gold prices and I don't pretend to really understand them either." Yet central banks continue to buy and sell gold.

In July 1999, when gold was hitting its 30-year price low of $250 per ounce, the Bank of England sold a massive amount of gold, solidifying the reserve banks in history as horrible market timers.

In 2012, when gold prices (NYSEARCA:GLD) averaged $1650 per ounce, central bankers around the world bought 535 tons, the most purchases since 1964. With gold now below $1400 per ounce, the world's bankers are again helping mark the top in gold as they have lost over $500 billion and counting since the great gold peak of 2011.

Euphoria and Emotion

As I outlined on March 22 when gold was trading over $1550 per ounce, it was no surprise to us that gold peaked in price in 2011 as euphoria went sky high.

The peak of pop culture's obsession with gold occurred right around the time that gold prices peaked at $1900 in late 2011. We don't see it as a coincidence that Pawn Stars was the second highest rated television show in 2011 just as another popular gold-focused television show, Gold Rush: Alaska , was in its inaugural season.


Countless treasure hunting television shows remain popular today.

Will History Rhyme?

The precious metals (NYSEARCA:IAU) have always been driven by euphoria -- or lack thereof. In 1980, the previous peak in gold prices sent shares up to $850, then a record. However, within two years, gold prices were back below $300, falling over 50% from its peak. Today, an investor that bought gold in the late 1970s would have lost money after inflation. According to the Fed Bank of Minneapolis, gold around $1400 today is worth only $464 in 1980 dollars, a far cry from the 1980 peak of $850, proving that even with the precious metals, there are good times to buy and also very bad times to buy.

Buying "at any price" is likely a losing strategy, just as it is with all assets.

If euphoria and emotion are what drive the prices of the precious metals, then we should use them to help identify when gold and silver (NYSEARCA:USLV) are good or bad purchases. We shouldn't rely on fundamentals or other justifications that simply don't correlate much with price.

Profiting From Gold and a Long-Term Projection

My firm has been fortunate to capture many of the great gold turning points (NYSEARCA:GDX) over the past year as my article Is the Great Gold Crash Over? outlines a few of them. Much of this was because we ignored the mainstream media and listened to our unbiased charts and sentiment measurements.

That analysis helped us capture profitable trades, both long and short on July 13, September 1, September 15, and September 18.

Last week, we suggested buying the Direxion Daily Gold Miners Bear 3x (NYSEARCA:DUST) to take advantage of another opportune technical setup. That trade was already up over 10% in less than a week. Our tandem trade of buying Dec GDX (NYSEARCA:GDX) put options was comparably up 30%.

Gold's long-term, medium-term, and short-term trends are decidedly down; using these charts, history, and sentiment measures help us target $1,000 for the price of gold.

The chart below of gold's ETF proxy helps put this target in perspective as gold is behaving very orderly from a technical perspective.



Gold's July rally to backtest its trend (shown by the green arrow) is a key technical setup that we combined with our short-term outlooks to help provide our September short recommendations when GLD was trading back above $135.

In reality, a gold decline (NYSEARCA:GLL) of 50%, targeting $1000, may actually be conservative as the 1980s price action taught us. Back then, precious metals (NYSEARCA:DGLD) gave back over 50% of their gains in just two years! But ultimately, they gave back over 70% by 1985.

Thus far, the gold decline (NYSEARCA:PHYS) has lasted two years, and prices have been chopped around 40%. Market history, the charts, and sentiment all suggest this trend should continue until gold bugs really start to throw in the towel.

At that point, it will likely be a good time to buy the metals again. However, that time could be years away, when the world's central banks and gold bugs finally completely throw in the towel.

Editor's note: This story by Chad Karnes originally appeared on ETFguide.com .

To read more from ETFguide, see:

Can Stock Market Volatility Stay Tame?

Will Stocks Follow Their Historical Pattern of 2011?

One Way to Get More Income From Your Portfolio



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Commodities , ETFs

Referenced Stocks: GLD , IAU , NUGT , USLV , XME

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