Gold was the safe investment five years ago. As of Friday, it is officially in bear market territory as it has depreciated by more than 20% from its recent peak of $1,900 an ounce in 2011. This morning, panic selling appears to be underway as gold is down by over 9% and silver is down by more than 10%.
It had become widely believed that as long as the Fed was infusing a trillion dollars of new money into the economy every year, the dollar would lose value and the only safe “currency” would be gold. The problem is gold is not a currency. It is not the year 1470 and Safeway Grocery Stores do not accept doubloons for bread, milk or meat. Whenever an investment view becomes too widely held, start taking a harder look.
The price of gold should be based on supply and demand. Much of the bullish argument for gold that falls outside of the category of backup currency is based on its being supply constrained. Gold cannot be manufactured and finding new gold is a slow process. On the other hand, demand appears to be steadily increasing. Gold is being accumulated by central banks around the world and countries like India are steady buyers. The theory is there should be positive pressure on pricing as a result of increasing demand and limited supply.
The problem with gold demand is much of the demand comes from price sensitive sources. From 2006 to 2011, 55% of all gold demand came from the jewelry market. Technology demand represented an additional 12%. The remaining source of significant demand is from financial buyers including gold based ETFs and central banks buying coins and bars.
Shown below is a long-term chart of gold prices. Gold reached a peak price in January, 1980. It is the only major investment asset category we are aware of that is still below its peak price of more than 30 years ago. From 1980 to 1985, gold prices declined by 67%.
The current price volatility of gold and the long-term chart suggest that gold is not the safe asset that many believed it to be. It suggests that financial speculation on the margin has a strong impact on pricing and the underlying supply/demand relationship is not sufficiently strong to overwhelm the effects of financial speculation.
Earnings Season So Far
It is early in the earning season, but with 31 companies in the S&P 500 having reported earnings, 64.5% have beaten expectations. This is modestly below the average which is 66%. But upside revenue surprises are running at 77.8% which is much higher than the average. Analysts expect 1Q earnings in aggregate to be 3.8% higher on average than currently estimated.
Our market sentiment indicator is currently in the low 62.1%. We remain bullish on the market. Having the indicator near the 50% level where we transition from bullish to bearish is a positive. It means that when we make new investments today, our stop-loss is tight – a move from 60% to 50% is much smaller than a move from 80% or 90% to 50%.
Review of Positions
Liberty Interactive (LINTA) – On April 9, we recommended to buy to open the LINTA Jan 2014 22 calls for $1.55. As of Friday’s close, these options closed at $0.70.
Charles Schwab (SCHW) – On March 7, we recommended to buy to open the SCHW Sep 18 Calls (SCHW130921C000018000) for $1.05 or less. As of Friday’s close, these options closed at $0.80.
EMC (EMC) – On January 10, we recommended to buy to open the EMC April 25 calls (EMC 130420C000025000) for $0.95 or less. As of Friday’s close, these options closed at $0.02.
Healthcare Trust of America (HTA) – On February 13, we recommended you buy to open the HTA Jul 12.5 calls (HTA 130720C0000125000) for $0.45 or better. On Friday, this position closed at $0.25.
Parting Shot: Market Sentiment Indicator
Shown below is our MSI (blue line) superimposed on the equal weighted S&P 500 measured by the ETF (RSP). We are bullish on the stock market when the MSI is above the 50% mark and bearish when it is below.
The scale for the MSI is on the left hand y-axis. The MSI has declined from 67.1% to 62.1% last week. With the MSI bullish in the intermediate term, we recommend staying long.
Have a great week trading,
Nick Atkeson and Andrew Houghton
Big Money Options