Gold's Troubles May Linger

 | Apr 15, 2013 | 5:00 PM EDT  | Comments
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nem

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abx

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gg

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aem

Like many people I've been watching gold plunge this morning, down nearly $100 at one point, with very little respite in the selling. At the same time I'm starting to see more and more bearish commentary in articles and on blogs all over the Internet.

There are even some conspiracy theories popping up that are blaming the Federal Government and Bernanke (of course) for crashing the price. (Bernanke and the Feds were also the "reason" for gold's rise as well.) None of this could have anything to do with the fundamentals, right?
As a contrarian, all this negativity is almost starting to make me bullish. I am still holding off on any purchases, however, because I think that despite the pounding there's still plenty more downside for the metal. I've been trading commodities long enough to know that their behavior is cyclical in nature -- they exhibit strong "mean reversion" tendencies. The only thing that varies from is the length of the cycle. It looks like gold and other commodities, however, are definitely reverting to their mean.

One way to analyze where we are in this cycle is to consider the average cost of production in the gold industry. That's a level that is likely to be tested or even surpassed (on the downside) before one can even consider a bottom. It is well known that the large miners like Newmont (NEM), Barrick (ABX), Goldcorp (GG), Agnico-Eagle (AEM) and some other companies have production costs ranging anywhere from $1400 per ounce on the high side down to $1,000 per ounce on the low side. Smaller mines may have a lower cost basis, but their output remains below the big players.

Mean reversion suggests that gold prices will move toward the cost of production and probably overshoot on the downside. Once there, the price can stay for a while. You may recall that gold traded at around $250 per ounce for more than a decade in the late 1980s and through the 1990s, forcing many miners to close. That spurred a reduction in output and supply and eventually set the stage for the bull market.

The most interesting thing is not gold's decline, but how high it rose on the false belief that central bank monetary operations were inflationary. I wrote about it many times (here and here) and have been talking and writing about this over the past five years, ever since the Fed and other central banks started to engage in these measures. It was never inflationary; it was only a big asset swap, yet people believed that it would stoke inflation and that triggered some major portfolio shifts. Today, this is all being unwound.

I have long said that gold is a bad investment. If you want to beat inflation you're far better off owning stocks, particularly dividend paying stocks, than owning gold. Gold pays you nothing, it costs money to own and the only way you can monetize is by selling it. You'd better hope that before you do sell, someone else just paid a higher price than what you paid.

Warren Buffet was right when he said something's wrong with an investment that involves taking a thing out of the ground only to put it back in the ground again. It just doesn't make sense. Some people may be finally realizing that.

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