When I went to the gold investment conference it was like walking into a ghost town. I got there just as gold stocks were trading down 10% for the day. I had never seen one of these conferences like this before. There were about a quarter of the booths as there normally are and hardly anyone was there. It made me wonder if in fact everyone had actually sold out. It certainly was a good sign from a contrarian standpoint
It wasn't just the number of booths that was surprising, but the lack of people listening to the presentations that was shocking. Over half the seats were empty. Someone told me it hadn't been this empty since the gold bear market bottom around 2000.
And the people who were in attendance weren't too chipper. To top it off there was even a black bird flying around. I couldn't take the negative energy and didn't stay around long, meeting people outside of the show.
I try to use trading tactics to find entry points in larger trends. I had thought in the summer that gold stocks would breakout and run through the end of the year in part in response to the coming blow up of Freddie and Fannie Mae. Based on this belief I use technical trading tactics to pick gold stock bottoms twice in the past seven weeks. When gold stocks bounced and then turned back down to go through my buy point I realized that I was wrong to think I had bought a bottom and sold. My stop loss points got hit.
The problem is with hedge funds and big investors who don't use a good game plan when it comes to money management. They refused to recognize that their trading models were no longer working and rode out their positions for huge losses. As a result they ended up selling in panic. And then another problem is retail investors who bought with no game plan and then sold out too.
Right now I don't have a position in gold stocks, but I'm going to watch them carefully again in the coming weeks. They do appear that they may have put in a bottom. I am worried though about the broad market possibly weakening them in the short-term, because the market is in a very precarious position, but if gold stocks base and provide a good entry point I will buy them again.
This is how a trader has to think, but if you are an investor in gold stocks then it really makes no sense to sell at this point. If you held through an over 50% drop that took place in less than two months it really makes no sense to sell. Unless gold is going to $500 there simply should not be much more downside to these gold stocks even if they made new lows again.
And I don't believe gold is going to $500, because I believe this correction isn't caused by deflation, but by hedge funds and large institutional investors who were overly leveraged blowing themselves up and selling to get off margin and to meet redemptions - a process that could last into the end of this year.
To put it this way if you held through a 50% drop as an investor it makes no sense to sell out in fear of another possible 10% drop. Large producing gold stocks are not going to zero.
We may have also reached a point with gold stocks that even if these people keep selling the stocks won't make new lows and fall hard anymore, because on a fundamental basis they have reached levels that make them so cheap that a bid from industry insiders and value investors could keep them from falling further.
Looking back at what has happened I think there is a very simple fundamental story going on - that is ultimately very bullish for gold. In July it became clear to the Fed and Treasury that Fannie Mae and Freddie Mac were going to have to be taken over by the government. The market was on shaky ground at the time so they took steps to intervene ahead of a takeover.
When Paulson announced the takeover of Fannie and Freddie last weekend he said he was acting at that moment, because the market was in a calming period. In his written announcement of the takeover he said the market was in a "time out" that made acting now prudent.
The Fed, Treasury, and SEC created this short-lived "time out" period. First the SEC created new short selling rules for a host of banking stocks in July to force a short-squeeze rally in them. Then the Treasury acted with the G-8 in early August to start some sort of rally in the dollar. These two moves helped spur a short-lived rally in the stock market in August, but more importantly started a correction in commodities and gold. That correction picked up steam and took a life of its own when it reached the point that it hit stop loss points and forced leveraged players to exit the market - that forced selling created what can only be described as a crash in gold stocks last week.
These moves were necessary to make so that a takeover of Fannie and Freddie could happen in a time of relative calm in the market. Imagine if the takeover was announced in July or right now what could have happened to the market.
I do not believe that the government is constantly intervening in the gold market. To pressure gold all they have to do is work together with several central banks to knock down the price through key support levels from time to time - or do so on the opposite end in the currency markets - and the selling will naturally pick up speed. This seems to be what happened in August. But in September I see the selling coming primarily from market participants stuck with huge losses instead of from than government intervention.
As a trader though I don't factor manipulation into my decisions. I base my decision on charts and trends in order to quantify my risk and set stop loss points. If I get stopped out due to a move caused by Fed intervention that is fine, because that intervention will likely drive the market much lower than my stop loss point and I rather not get hurt by it. As an investor one has to simply decide how much of ones assets one is comfortable holding for the long-term no matter what temporarily losses could occur.
Ultimately the Fred and and Fannie news is going to be bullish for gold, because it is going to mean that the Treasury Department is going to end up printing hundreds of billions of dollars over the next two years or so to pay for their losses - and that addition to the national debt will eventually be a drag on the dollar. This is why I find the deflation story hard to swallow.
That is the future. Last week and now though is a different story. In periods of deleveraging investors sell assets and go into cash. Since most margin is done through dollars that means a demand for dollars to raise cash to get off margin. And once institutional investors are in cash their money flows into money market funds and Treasury bills - hence the rising bond prices in the face of what will eventually be an even more inflationary environment.
Mike Swanson is Editor, Wallstreet Window
