How Will Gold React to Economic Decline?

I don’t see much future for the United States, and I put it on economic grounds. Forget moral grounds. We’re far beyond any known morality, and we are embarked upon a kind of war against the rest of the world. We are going to go broke. The dollar loses value every day. So, I put it down to economic collapse may save the United States from its rulers. – Gore Vidal

Politics aside, I started writing an article a few days ago in which I was calling a top for the Dow. Yesterday’s selloff seems to have confirmed my suspicions. The Shanghai Composite index sank 8.8 percent and dragged down economies worldwide along with it. The Dow Jones industrial average and the Standard & Poor’s 500 Index both closed down more than 3 percent, marking their biggest one-day percentage drops in nearly four years. The Nasdaq suffered its biggest decline since December 2002. And all across the globe emerging-market ETFs were hit hard.

Impact on Gold
Gold, silver and energy all took a beating amidst the general market decline. The Amex Gold Bug Index (HUI) declined nearly the same percentage as the Shanghai Composite index. Was this selloff in gold stocks justified? Should the price of gold be moving in lockstep with the Chinese economy?

We believe the selloff was an emotional, panic-induced reaction that provides an excellent buying opportunity. While declining demand for base metals is a more legitimate concern, the price of gold should be mostly immune to a market decline. If anything, the selloff in Chinese stocks will likely increase the demand for gold within China. Investors seeking to exit a toppy Chinese market, will seek safer investments alternatives. Throw in the fact that the goverment has recently made it easier for Chinese citizens to invest in gold and you have plenty of reason to believe the gold price will find adequate support.

We are optimistic about the gold market, believing the fundamentals haven’t changed. But it is worth noting that some analysts, including long-term gold bugs, are anticipating a major correction in gold this year. Anything is possible in this market, but we don’t see a correction on the horizon at this point. However, the next few weeks will be critical in confirming if this rally has legs, so it is wise to keep a close eye. If gold takes out the psychologically important $700 mark, it should be clear sailing to new highs.

Gold and gold mining shares, despite a short term disappointment will surely recover as the investing world has been given a wake up call on the frailty of paper assets owned by global investors. Base metal stocks will also recover as the China and India growth story has many years to go. – Ken Gerbino

I also like this quote from Andre Bakhos, president of Princeton Financial Group in Princeton, New Jersey:

There seems to be just an air of nothing is safe anymore, there’s nowhere to go and people are rotating into bonds as a safe haven.

Well, I can think of another investment viewed as a “safe haven” during times of economic uncertainty. Furthermore, I find it hard to believe that investors, fresh from realizing impressive gains in the stock market, would simply move their funds into bonds. The returns are simply too low and the action is too slow for a good majority of investors. That being said, we may see some sideways trading as investors step back and assess the situation. However, we fully expect gold to continue its run towards $700 in the coming weeks.

Emerging-Market ETFs
We are holding our positions in emerging-market ETFs, as we believe the panic-selling was overdone. At the time of writing, most of these ETFs had already regained about half of yesterday´s decline. We are convinced that the economies of China, India, Japan and Latin America still have plenty of growth ahead of them.

Housing Market
We can’t say the same for the U.S. economy and we are considering shorting the housing sector. New-home sales plunged 17% in January. This was the biggest percentage decline in 13 years and may signal a coming deflation, if not burst of the housing bubble. This bubble has been the most significant force keeping the U.S. economy afloat.

Conclusion
We intend to stay long gold and silver stocks and will wait for confirmation of the recent rally before adding to our positions.
We will also remain long energy and emerging-market ETFs, as the one-day fiasco in the Chinese market was overblown and not a true sign of slowing growth. Today’s rebound supports this view.
We are looking to reduce positions in U.S. stocks and consider shorting the housing sector.

Good luck and happy investing.

By | 2007-03-14T13:13:10+00:00 February 28th, 2007|Gold & Silver Commentary|

About the Author:

Jason Hamlin is the founder of Gold Stock Bull and has been investing in precious metals for over 20 years. Jason spent nearly a decade in analytics for the world’s largest market research firm, before finding success investing full time. He launched Gold Stock Bull in 2005 and turned his focus from helping fortune 500 companies to helping individual investors. Jason is a student of Austrian economics and a proponent of cryptocurrencies such at bitcoin.