Shorting Gold—The DUMBEST investment advice I have heard in a long time

Louis Basesense from Seeking Alpha reports about 12 Reasons to Short Gold.

(emphasis mine) [my comment]

12 Reasons to Short Gold
by: Investment U February 11, 2009 about stocks: GLD / IAU
By Louis Basesense

[This article was emailed to me, and I felt compelled to write a response]

If you' re a self-professed “Goldbug,” feel free to read no further. Or at least spare me your hate mail. Because no matter what I say today, I know you' ll cry foul… or something much more colorful.

But for those of you with an open mind - especially after my last three contrarian predictions proved dead accurate - read on.

Because it' s time to start shorting gold!

[FLAW#1: Louis Basesense doesn' t consider the possibility of a dollar collapse.

Going short gold is going long the dollar. In other words, if the dollar' s value crashes against foreign currencies, gold prices in dollars will skyrocket. ANYONE who writes an article about shorting gold in this environment without considering the possibility of a dollar collapse is an idiot, pure and simple.]


You won' t find many, if anyone else, making this case. But as the first reason of 12 below reveals, that' s precisely why you should give it more credence.

12 Reasons To Start Shorting Gold

1) It' s decidedly contrarian. If a contrarian investor is someone who deliberately decides to go against the prevailing wisdom of other investors, shorting gold certainly fits the bill. Right now, everyone else is buying gold, or at least recommending it. If you have any doubt we' ve reached such fever pitch levels, consider No. 2.

[FLAW#2: Believing the dollar won' t collapse doesn' t make you a contrarian, it makes you part of the mainstream. Is gold the world' s reserve currency? Are investors around the world hoarding piles of gold? Is the word “cash” equated with gold? The answer is no. The dollar is the world's reserve currency, investors are hording piles of dollars/treasuries, and the word cash still means dollars (for now). Anyone shorting gold ends up sitting on a pile of dollars, just like the rest of the world. In what way is this contrarian?

No, as long as Mike “Mish” Sherlock remains in the deflation camp, buying gold is the contrarian play]


2) The infomercial factor. The best indicator of a turning point for any investment, in my experience, is infomercials. If an investment gets so popular it invades the pre-dawn hours with non-stop but-wait-there' s-more offers, it' s time to get out. And that' s exactly what' s happening now. So much so companies like Cash4Gold.com are invading primetime television. They even splurged for a Super Bowl ad spot. And they recruited washed-up celebrities Ed McMahon and M.C. Hammer to boot. In case you forgot, the Hammer filed bankruptcy in 1996. And Eddie boy almost lost his 7,000 square-foot, $6.5 million Beverly Hills pad to foreclosure. No offense, if you take investment cues from these two, you deserve to lose money.

[FLAW#3: Anyone who bases their investment decisions from “the infomercial factor” deserves to lose money.

Question for Louis: How do you ridicule investors from taking cues from Super Bowl ad spots, and then, IN THE SAME PARAGRAPH, urge investors to short gold based on cues from Super Bowl ad spots.]


3) There is always some truth in a rumor. Recent news reports suggested Germany, the world' s second-largest holder of gold, was selling some from its vaults to trim its deficit. It turned out to be a rumor. But you gotta wonder if there' s some truth behind it. After all, high gold prices would be an easy way to raise cash. In other words, the scenario is completely plausible. And if Germany' s considering it, even remotely, so, too, are plenty of other deficit-ridden governments. It goes without saying that a government dumping supply on the market will send prices lower, quickly.

[FLAW#4: Central banks' selling off their reserves to fund deficits is INCREADIBLY bullish for gold, because the majority of those reserves happen to be in dollars. For example, China, who is also running a deficit, only has 0.9% of its reserves in gold but has close to 2 trillion dollar assets available for sale. If as Louis suggests, central banks start selling reserves to fund their deficits, the dollar will get killed and gold prices will fly into the stratosphere]


4) The gold-to-oil ratio is out of whack. Historically, an ounce of gold will buy you about 14 barrels of oil. But with oil around $40 per barrel, an ounce of gold gets you almost 23 barrels - a whopping 64% above the historical mean. If you believe in statistics, a reversion to the mean is imminent!

[FLAW#5: Comparing gold to oil is comparing apples to oranges. Gold is an investment whose value is determined by ebb and flow of confidence in paper currencies. Oil is a demand-driven investment whose value is highly dependent on the business cycle. Applying statistics to compare these two assets is stupid. (I do expect oil to revert to the mean in about a year and a half, when global demand begins to recover from the dollar' s collapse.]

5) So is the gold-to-silver ratio. Historically, an ounce of gold will buy you 31 ounces of silver. But now the ratio stands at 73 - an unbelievable 134% above the historical mean. Here, too, a reversion to the mean is imminent. And I' d rather place my bets on a 57% decrease in the price of gold, than silver more than doubling to make it happen.

[FLAW#6: Louis bets on deflation without even bothering to explain why.

Here, Louis openly betrays is mindless belief in deflation: he would rather bet on a “57% decrease in the price of gold” (deflation) than on the doubling of silver prices (hyperinflation). This proves that Louis buys into the mainstream idea of deflation and is no contrarian.

In fact, Louis belief in conventional wisdom of deflation is so total that he doesn' t think it even needs to be explained.]


6) The HGNSI index is too high at 60.9%. For the past 25 years, Hulbert Financial Digest has tracked the average recommended gold market exposure among a subset of gold-timing newsletters. It usually fleshes out around 32.6%. But now it rests at 60.9%, a level it' s only exceeded 13% of the time. The key - Hulbert found an inverse correlation exists between his proprietary index and the short-term market direction of gold. In other words, if the index is high, like now, gold is headed lower.

[FLAW#7: After a year that has made a mockery of all manners of technical signals, Louis believes traditional ways of foretelling market direction still apply. Think about it: if the dollar is about to collapse, wouldn' t you expect the HGNSI index to be high?]

7) Trinkets drive demand, not governments or speculators. Nearly 75% of gold demand comes from the jewelry market. And if Indian brides balk at buying above $750 per ounce as the Bombay Bullion Association reports - India' s gold imports cratered 81% in December - look out below. And don' t be fooled into thinking investors (governments or speculators) will pick up the slack. As HSBC reports, rising demand from investors, particularly from ETFs, only offset half of the 33% decline in jewelry market demand since 2001.

[FLAW#8: Louis assumes that the gold market will return to “normal”.

A) When the world was on the gold standard, 90% of the demand for gold came from governments and speculators.
B) In recent year, “75% of gold demand comes from the jewelry market”

Despite a seven year trend of “rising demand from investors, particularly from ETFs”, Louis assumes we will be returning to “normal”, trinkets-driven gold market.]


8) What makes now “different?” If the global economic crisis keeps getting worse, as goldbugs like to point out, why hasn' t gold tested last March' s high of $1,030.80 per ounce? Or blown right by it? After all, gold is supposed to increase in value as economic conditions worsen. But it hasn' t lived up to expectations, not one bit. And I don' t think it ever will. Ultimately, when you factor in the massive amounts of stimulus being injected into the markets, on a global level, we' re close to the worst of times… and the peak for gold.

[FLAW#9: Louis doesn' t think now is “different”

Now is unquestionably “different”: These are unprecedented times

“why hasn't gold tested last March's high of $1,030.80 per ounce?”

Because in the second half of 2008, hedge funds were forced to sell large quantities of gold to deleverage and meet redemptions demands

“Or blown right by it?”

Gold hasn' t blown “right by it” because everytime gold tried to do so last year, some of the fed' s big member banks (ie: JPMorgan) sold huge quantities of “paper gold”.

“After all, gold is supposed to increase in value as economic conditions worsen.”

Yeah, that is strange isn' t it? It almost seems like there is someone out there who is intentionally suppressing gold prices as they try to rally.

“it hasn't lived up to expectations, not one bit.”

It was only one of the best performing assets of 2009.

“I don't think it ever will”

Saying that is about as stupid as saying we will never seen inflation again. Gold prices were around $40 in 1970.

“when you factor in the massive amounts of stimulus being injected into the markets, on a global level, we're close to the worst of times”

Those who believe we can print/spend our way to prosperity are fools.]


9) Analysts love it. According to Bloomberg, 16 of 24 analysts surveyed by the London Bullion Market Association believe gold will reach a minimum of $1,032 per ounce this year. As we all know, analysts' track records are deplorable. Instead of just ignoring them, why not bet against them? The odds are definitely in our favor.

[FLAW#10: Louis uses blatantly bias evidence. How can someone claim “analysts love gold” based on a survey conducted by “the London Bullion Market Association”?]


10) Hedge fund buying dried up. Institutional speculators (hedge funds) played a large part in gold' s run-up. But 920 of them went Kaplooey last year, according to Hedge Fund Research, Inc. Not to mention, hundreds of others hemorrhaged capital as investors demanded their money back, while those left standing ratcheted down borrowing to close to nothing, according to Rasini & C., a London-based investment adviser. In the end, gold prices will eventually reflect the absence of these former heavyweights.

[FLAW#11: Hedge fund buying didn' t “dry up”.

For the last six months, hedge funds have been selling billions of dollars worth of gold to deleverage and meet redemptions demands. Only recently has this hedge fund selling ended.

When six months of intensive selling by hedge funds has come to an end, is the correct expression:

A) “Hedge fund BUYING dried up.”
B) “Hedge fund SELLING dried up.”

Louis believe the answer is A.]


11) Gold is schizophrenic and the wrong personality is in control. Multiple motivations exist to buy gold including the desire for a safe haven, currency, adornment, raw material, or inflation hedge. But much like Treasuries, the bulk of buyers come from the safe haven camp today. And once the economy shows any signs of perking up, we can expect these same investors to flee for more risky assets. And don' t be so quick to rule out a second half recovery…

[FLAW#12: An economic recovery (which I don' t believe will occur) would be a BULLISH development for gold. The majority of economists expect the US' s economic recovery to trigger serious inflation, causing a big rise in gold prices.]

[FLAW#13: Louis suggests “a second half recovery”. Bullish comments like this are the reason this site is called Market Skeptics. I have ZERO tolerance for those who make weak bullish projections in the face of overwhelmingly bearish evidence. These delusionally optimistic comments are misleading for everyday investors.

For there to be a recovery in the second half of the year, the US would have to escape its crushing debt burden and somehow resurrect its manufacturing sector. Both of these are impossible without a dollar collapse.]


12) The Fed, the President, history and the Baltic Dry Index concur - the economy' s on the mend. Despite dismal data, both the Fed and President Obama point to the current recession ending by the second half of 2009 [Politicians always forecast economic recovery in the middle of a recession!]. Moreover, the average recession only lasts 14.4 months [This is OBVIOUSLY not an average recession]. So even if this one is longer than usual, we' re still near the tail end of it - a fact underscored by the recent 61.4% rally in the Baltic Dry Index from its early December low [The rise in the Baltic Dry Index is actually a clear signal that the US economy is on the verge of collapse. If Louis thinks this is an optimistic development, it is because he doesn' t have a clue what is going on]. As I wrote in November 2008, the index is the first pure indicator of an uptick in global activity [“An uptick in global activity” doesn' t meant an uptick in US activity]. And once the economy gets back into gear, the Fed will act quickly to rein in the money supply and curb inflation.

[FLAW#14: The 61.4% rally in the Baltic Dry Index is being driven by the shipping of grains, not renewed consumer spending. It is evidence that global droughts are forcing nations around the world to import more grain, and means global food inflation. Rising food prices will end deflation fears and cause a panic into gold.]

[FLAW#15: the Fed will unable to “act quickly to rein in the money supply and curb inflation”.

For the US/fed “to rein in the money supply”, it would have to:

A) Stop bailing out banks and allow the financial system to crash
B) Back out of all government guarantees (FDIC, etc…) to avoid printing more cash
C) Default on the US' s federal debt
D) Eliminating social security and medicare, because when the US defaults, it will wipe out the trillions of dollars worth of treasuries held held in trust to pay for the baby boomers retirement. US default = no more social security or medicare.

Somehow, I doubt the US/fed would be willing to take the steps needed to “curb inflation”]


Clearly the gold rush is on [no it isn' t. The majority of investors are still in “cash” (dollars)]. But that' s all the more reason to move in the opposite direction, against the herd. I realize this might be the most unpopular recommendation right now, but that means it could also be the most profitable.

And before you brand me a fool [you are a fool] for recommending shorting Treasuries and gold in the span of two months, here' s the intersection. The driving force behind both assets in recent months has been safe haven buying [, but the fears have been different.]. And it will remain the dominant variable in determining price in the months ahead. So when investors go back on the attack for more risky assets, prices for both assets will fall.

[FLAW#16: While the “driving force” behind gold and treasuries “has been safe haven buying”, this safe haven buying has been buying driven by two different fears. Those buying treasuries are afraid of deflation, and those buying gold are afraid of hyperinflation. Because of these different fears, gold and treasuries are unlikely to move together.]

It' s already happening for Treasuries. And I' m convinced gold is next.

[FLAW#17: Falling treasuries means deflation fears are being discredited, and it makes gold more attractive.]

Investment U Editor' s Note: In the past year, Lou' s been dead on with his predictions. He called the U.S. dollar bottom versus the euro within 26 days… oil' s peak within 24 days… and the top in U.S. Treasuries within two days. So when he makes a big call like this, we listen.

[My predictions over the last year and a half have also been pretty dead on. This makes me want to dig up another batch of my old emails.]

My reaction: I don' t know why, but taking apart this article was rather refreshing. Below is the summary of the 17 flaws in Louis Basesense case for shorting gold:

FLAW#1: Louis Basesense doesn't consider the possibility of a dollar collapse.
FLAW#2: Believing the dollar won't collapse doesn't make you a contrarian, it makes you part of the mainstream.
FLAW#3: Anyone who bases their investment decisions from "the infomercial factor" deserves to lose money.
FLAW#4: Central banks' selling off their reserves to fund deficits is INCREADIBLY bullish for gold, because the majority of those reserves happen to be in dollars.
FLAW#5: Comparing gold to oil is comparing apples to oranges.
FLAW#6: Louis bets on deflation without even bothering to explain why.
FLAW#7: After a year that has made a mockery of all manners of technical signals, Louis believes traditional ways of foretelling market direction still apply.
FLAW#8: Louis assumes that the gold market will return to "normal".
FLAW#9: Louis doesn't think now is "different"
FLAW#10: Louis uses blatantly bias evidence.
FLAW#11: Hedge fund buying didn't "dry up".
FLAW#12: An economic recovery (which I don't believe will occur) would be a BULLISH development for gold.
FLAW#13: Louis suggests "a second half recovery".
FLAW#14: The 61.4% rally in the Baltic Dry Index is being driven by the shipping of grains, not renewed consumer spending.
FLAW#15: the Fed will unable to "act quickly to rein in the money supply and curb inflation"
FLAW#16: While the "driving force" behind gold and treasuries "has been safe haven buying", this safe haven buying has been buying driven by two different fears.
FLAW#17: Falling treasuries means deflation fears are being discredited, and it makes gold more attractive.

This entry was posted in Background_Info, Currency_Collapse, Gold, Market_Skepticism. Bookmark the permalink.

0 Responses to Shorting Gold—The DUMBEST investment advice I have heard in a long time

  1. vahadad says:

    Dear Eric, Thanks for the rebuttal. For a moment I was confused and rechecked all your earlier submissions and was convinced that you are on the right track. Now I am very much convinced after reading your article identifying the flaws. I could find a few but you had presented concise reasons for all points. Thanks. Whats your prediction on targeted price for gold March 2009?. There will be a lot of red blood when the balance sheets come in and I am expecting a spike to $1300. Do you concur?
    Regards , Krishna

  2. Anonymous says:

    have fun feeding and protecting your family with gold. And what will you trade it in for....useless dollars?

    How many vendors are equipped to trade gold, and how safe are you with trading with them??

    I don't see any correlation between the TNX and GOLD...can you expound on that correlation?

  3. andy says:

    Great article; I saw on Mish's site a good post trying to explain why gold fell in value from the 1980's to the early 2000's. I really don't understand his article. Plus I have seen Mish state that he likes gold.

    Anonymous:

    I bet you all the money in the obama bailout that I can go into any store in the world and pay with gold.

  4. Anonymous says:

    Flaw 18: The Cash4Gold ad is to BUY YOUR GOLD! Not to sell gold to us, but to buy it from the public. Shouldn´t a gold bubble work the other way round, paying advertisements to sell you the bubble asset?
    OK, you are contrarian to whom, to Cash4Gold or to the people that sell their gold?

  5. JF says:

    We spend billions of dollars to dig gold from the ground, only to lock it forever in a safe...

  6. andy says:

    Anonymous:

    Thank's Warren Buffet, citing Milton Freedman... If you didn't notice we do the same thing with dollars, except we can make as many dollars as the fed deems appropriate.

  7. Leon says:

    "FLAW#14: The 61.4% rally in the Baltic Dry Index is being driven by the shipping of grains, not renewed consumer spending." - is inaccurate.

    Grain is shipped via handysize (component of BDI), however, BDI's recently rebound was not due to shipping food around as handysize made almost no impact on the BDI rally.

    Rally was due to raise in Capesize and Pannamax which both are used to ship ore and other commodities.

    However, BDI's rally is over as it will be range bounded from now. and your theory on shortage in food will be disproven.

  8. Anonymous says:

    maybe Andy. But during a mad max scenario (which is what you are implying), I hope your half dozen bodyguards take payment in gold too.

    Do you think everyone is going to be walking around with gold nuggets in their pockets? What store will be open if currencies collapse?

    Sorry, it may be a good hedge in some circumstances. But tools, seed, guns, ammo, food, water and good health seem to be the best instruments for survival.

    Besides...I can't afford gold!

    Peace.

  9. BD says:

    Anonymous-

    Dude, you are GUESSING. Go post some idiot statements like that on some argentina message boards, they lived thru what we are about to. Find someone who went thru a currency collapse and ask them if gold is useless... hahahah

  10. David says:

    The flaw with #2 (the infomercial factor) is that the infomercials on TV are to get people to SELL their gold not buy it! If the author thinks infomercials are a bad sign he should be really worried since the infomercials are pushing his view that people should sell gold. He's AGREEING with the infomercials! Talk about being on the wrong side of a trade.

  11. Numonic says:

    "[FLAW#15: the Fed will unable to “act quickly to rein in the money supply and curb inflation”.

    For the US/fed “to rein in the money supply”, it would have to:

    A) Stop bailing out banks and allow the financial system to crash
    B) Back out of all government guarantees (FDIC, etc…) to avoid printing more cash
    C) Default on the US’s federal debt
    D) Eliminating social security and medicare, because when the US defaults, it will wipe out the trillions of dollars worth of treasuries held held in trust to pay for the baby boomers retirement. US default = no more social security or medicare.

    Somehow, I doubt the US/fed would be willing to take the steps needed to “curb inflation”]
    "

    Even if all this happened, it would only be bad for (debt)paper money and bullish for gold and silver. Who would trust debt after so many defaults? Or who would trust paper as money given the problem paper money brings with it's easy susceptability of being over printed. Why even choose to use paper as money with a promise not to over print when you have things like gold and silver that make it hard and damn near impossible to over supply. Anyone that suggests we use paper instead of gold and silver with a promise to not over print is just trying to fool whomever he is suggesting that idea to. Why go through fighting resisting over printing the money supply when you have things like gold and silver that make it hard and damn near impossible for that to happen. I can't believe people fell for that when we went off the gold standard. It's impossible to keep the promise to not increase the money supply and maintain Fractional Reserve Banking at the same time because FRB increases the money supply.

    I am absolutely convinced not only that we will see a return to physical gold and silver being used as money very soon but also that gold and silver being used as money will be better for the world and will create jobs and improve production and standards of living in all economies in the world. The best thing about it is that it is inevitable. There is nothing no one can do to stop it. This calls for celebration we are witnessing the beginning booming economies all over the world with gold and silver's return as money.

    Check this article out:

    Gold: the protector and creator of jobs

    http://www.silverbearcafe.com/private/02.09/protector.html

  12. Numonic says:

    Another funny excuse people use against gold/silver is that it's cumbersome to carry around. Like carrying around wheelbarrows of dollars is any easier. And I think that's the last excuse people have against precious metals being used as money but since holding paper will become more cumbersome because you'd have to carry so much to buy so little, that excuse looses value and precious metals being used as money wins in every aspect against paper.

  13. Mark Herpel says:

    Why stop buying when it feels soooo right! The small kilo bars make great paperweights.
    Mark
    DGCmagazine

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