The gold panic of 2013
Bill Fleckenstein

I was out of the country last week and thus did not post a column, but readers are no doubt aware that the gold market tanked about 14% between Friday, April 12, and Monday, April 15. So I will be devoting this week's column to that subject.

The first big question to consider is, Does this slide have predictive value? Does it tell us anything about the future?

I don't believe it does.

The 1987 stock market crash (which was similar to the Friday-Monday panic selling) certainly had none. It was about poor fundamentals and people not adjusting to them because of portfolio insurance, which detonated like a bomb. Yet the market break didn't "tell" us anything.

The gold market itself has experienced similar declines in the past, which have predicted nothing. in 1976, gold dropped from a high of $198 to $105 an ounce, a decline of about 40%. Interestingly enough, the last three days of that decline saw the market drop about 12% (similar to the amount lost during trading on Friday and Monday).

However, that collapse was a giant head-fake. Within about a year gold was back to its previous high (that would be $1,900 in today's environment), and over the course of the next four years it traded up over eightfold from those lows, even as our Federal Reserve (under Paul Volcker) was trying to do the right thing in the end. (And when it was pursuing the wrong policies, prior to Volcker's appointment, that was kid stuff compared with what the Fed and the rest of the world's central banks are doing today.)

What we just witnessed in the gold market, in my opinion, was a panic liquidation that has no predictive value and which occurred in the teeth of the most wildly gold-friendly fundamentals the world has ever seen. Unfortunately, this is a lesson of markets sometimes being perverse and doing whatever they want to.

'I must be crazy to be in a loony bin like this'

The second topic to consider is investor psychology. Obviously, psychology plays a huge role in markets, and it seems quite clear to me that a vast majority of the American investing public believes that it is 2007 again.

I say that because virtually all the people who missed the housing bubble are now sanguine about the real estate market, the stock market and the economy. In fact, it seems as if many are downright giddy. It is as if 2008 never occurred (or 2001-2003, either).

For some reason, this Pollyanna/Goldilocks crowd is incapable of seeing the obvious, in that they are in total denial regarding the negative effects of central bank policies. They cheer money-printing, as it takes stock prices higher and boosts the economy ever so slightly, but they refuse to worry about its consequences, not the least of which is inflation.

By extension, they also have complete faith in the very institution that has wrecked the economy and financial system: the Fed.

 How people can rationalize the inflation we are experiencing is beyond me, but that is where we are. That will change, but it is not possible to know when.

I believe this clueless bullish glow about everything being OK is one of the reasons there is so much hatred for gold. Back in 2007, none of these out-of-touch Goldilocks types really cared about gold. Back then, the price was, say, $600 an ounce after rallying from a low of $275 in 2001, but nobody really paid attention. In essence, they couldn't even spell "gold."

'That's right, Mr. Martini, there is an Easter bunny'

Now, however, gold has traded as high as $1,900 and generated a lot of news, such that the Pollyanna/establishment people have come to view it as a threat to their worldview. In other words, if gold is rallying, perhaps something might actually be wrong (although I'm not sure they even think that), but what they believe for sure is that a decline in gold prices means their view that "all is right with the world" is correct.

Thus, they have a vested interest in rooting gold lower.

That is why there is such massive hatred of it and there are so many negative articles in every mainstream publication (and why Wall Street especially hates gold).

Meanwhile, the people who can see through all the hype and nonsense and who own gold are in the minority, especially in the U.S. In other parts of the world, such as Asia -- where there are physical and central bank buyers -- people do not succumb to the same delusions. In the end, the physical market will win out, but in the short run, the paper market has so much more volume and is so large that it is the tail that wags the dog.

The Goldilocks crowd will soon realize, once again, that its optimism was misplaced and it will be disabused of the view that the economy will be OK this year (this is the third year in a row that a bit of good news in the early part of the year had folks convinced that everything was going to be rosy thereafter).

Again, the culprit for such silliness is the massive amount of money-printing in the world, which is currently larger than ever. (The Bank of Japan and the Fed combined are conjuring up approximately $1.8 trillion of high-powered money each year, an unfathomably large number, which will ultimately be viewed just as negatively as it had previously been thought to be positive.)

In hindsight, I believe the leg up in the gold market, which ended in September 2011 at $1,900, was about people reacting to central bank actions and the positive price response in the gold market brought in lots of people simply because the price was rising.

Since then, the chart pattern and the market's reaction to news have been negative, culminating in the giant smash we had on Monday. I believe this drubbing marks the end of the last couple of years of bear-market action in gold, and the next leg up will be a function of people recognizing that all this central bank lunacy has erroneous negative consequences.

'The best thing we can do is go on with our daily routine,' said Nurse Ratched

Said differently, the increase in the gold price from $300 to $1,900 was about central bank actions, and the next leg will be about the consequences of those actions. This is because, so far, people have believed there have been, and will be, no consequences, but that is totally untrue. Rising gold prices will silence most of the naysayers, but how fast they may convert into buyers remains to be seen.

Perhaps Americans are going to be in denial until the completely rigged Consumer Price Index registers 6%. But  money-printing here and everywhere else is going to lead to massive inflation and other problems, and the only way one can be adequately prepared is to have some exposure to precious metals. (How much is a very personal decision.)

Unfortunately, as this recent episode demonstrates, the personality of the metals is quite volatile, given that, besides being a store of value, the metals are "just" a price, which makes it very difficult for people not to become emotional when that price swings to and fro.

I hope that description of psychology and what has transpired is a useful framework for people to use to navigate prospectively.

At the time of publication Bill Fleckenstein owned gold.

I have been a professional money manager since 1982. I began writing my daily market commentary in 1996 and launched FleckensteinCapital.com in 2003. Initially, the Market Rap was a daily recap of market events, with an added "Yes, but..." emphasis. I quickly learned that the contrarian viewpoint was often misrepresented and under-reported. Since then, my daily column has always called it like I see it. I've tried to write in a way that even the novice investor can understand. I believe it's better to teach someone how to fish, rather than just give them an occasional fish.

www.fleckensteincapital.com