That’s the depressing assessment from Claude Erb, a former commodities portfolio manager for Trust Company of the West, and co-author — with Campbell Harvey, a Duke University university finance professor — of an academic study from last June that is looking to be increasingly prophetic.
In that study, the authors calculate that gold’s fair value is close to $800 an ounce. Though many of gold’s true believers were inclined to dismiss such a bearish projection when their study came out, it’s beginning to be taken a lot more seriously: Bullion’s recent slaughter has eliminated more than 40% of what a year ago they concluded was bullion’s overvaluation — including $240 over the last week alone.
These developments prompted me to check in with them to see if these recent developments had in anyway softened their bearish assessment.
No such luck.
On the contrary, Erb told me Monday morning, he thinks it is unrealistic to expect gold’s decline “to play itself out very quickly.” Referring to the five stages of grief that were made famous by Elisabeth Kubler-Ross, he believes the gold market right now is just in the first stage: denial.
The next four stages, for those of you who need reminding, are anger, bargaining, depression and, finally, acceptance.
As evidence of many gold investors being in denial, Erb referred to the large number of institutional investors and hedge fund managers who continue to own substantial gold positions. The “Denialists are like those in 2007 who thought real estate would go up forever, or Jim Glassman’s famous book at the top of the Internet Bubble projecting DJIA 36,000.”
Erb continued that these institutional investors and hedge-fund managers in coming days will have a lot of explaining to do with clients for why they didn’t anticipate gold’s plunge — and to convince those clients in any case why they should continue to invest in gold.
If those investors and managers lose the faith and decide to sell, and even if they don’t but if their clients do, then a huge amount of additional selling pressure will hit the gold market.
For a fuller discussion of the hard questions that Erb and Harvey ask about gold, read my early-February Barron’s column about their research. But to come up with an estimate of gold’s fair value, they calculate a ratio of gold to inflation going back as far as they were able to obtain data. They report that this ratio, when expressed in terms of the U.S. Consumer Price Index, has averaged about 3.2-to-1. Even at $1,400 an ounce, this ratio stands at 6.03-to-1, or nearly double this average.
Much of the reasoning behind the bearish sentiment on gold stems from the perception that the Fed may end early its $85 billion a month "asset purchases program." Minutes of the recent FOMC meeting revealed that a few members of the committee had voiced opinions that the program could end early. A few weeks earlier, leaked minutes indicated the same. What's important is that Bernanke's office came out and said that it would tighten the controls on minutes because they had been misinterpreted, that asset purchases (Quantitative Easing) would continue until the economy had sufficiently improved.
It has now been five years since the Global Financial Crisis, and trillions of dollars have been created to save the world's financial system and to revive the economy. Perhaps it can be argued that the financial system was saved, but arguments that this massive money creation has stimulated economic activity are weak. The best the money creation advocates can claim is that a depression was averted, but that is a claim that cannot be proven.
We can expect continued money creation as Bernanke promised. If the economy worsens, we can expect an increase in money creation. Money created "out of thin air" is inflation, which results in an overall increase in prices. Just because we have not yet seen huge across the board price increases does not mean they are not coming. Historically, we have always had price inflation following monetary inflation.
Meanwhile, do not be crushed in this gold smash. Nothing would being the manipulators at the bullion banks more satisfaction than to buy your gold and silver at these low levels.