On January 21, 2010 we initiated our short position in gold via the Proshares Ultrashort Gold Fund (NYSE: GLL). We are now closing this position, as GLL hit our pre-specified stop of $37.95 (split adjusted). Our loss on this position was limited to 25%, or 2.5% of the total portfolio.
This is a difficult move for us, but we consider it the right move. We continue to believe that gold is in an irrational speculative bubble driven by a potent combination of fear, angst, and political ideology. But as John Maynard Keynes noted, “The market can stay irrational longer than you can stay solvent.” And as we wrote when we initiated this trade, “The problem with making a contrarian call is that you can be ‘right’ but still lose a lot of money if you are too early. Just ask anyone who tried to short the Nasdaq during the 1990s bubble.”
We continue to see gold’s fundamentals deteriorate. Demand is almost entirely in the hands of new portfolio investors and hedge funds and particularly by exchange-traded funds such as the SPDR Gold Trust (NYSE: GLD). GLD now holds 42.05 million ounces and its holdings are up more than 7% in the past week alone, according to the Financial Times. Traditional demand for gold—such as for jewelry—have been in decline for years, as high prices have discouraged buyers. Even India—traditionally the biggest buyer of gold in the world—has substantially reduced consumption over the past five years.
In 2009, investors purchased more gold than jewelry buyers for the first time since 1980—which happened to be the year that the last gold bubble burst and ushered in nearly three decades of declines for the yellow metal.
Gold is in a speculative bubble, and shorting it is “logical.” But the truth is that bubbles can go much higher than anyone believes, and we cannot put our investors’ capital at risk. Nasdaq stocks were already priced at absurdly high valuations by the mid-1990s—as Greenspan noted in his “irrational exuberance” speech—yet the bubble did not burst until 2000. Sensible investors who attempted to short tech stocks during that period would have been wiped out.
So, as bearish as we remain on gold, we are following our sell discipline and exiting this trade.
Charles Lewis Sizemore, CFA
