Earlier this afternoon, Keith shorted the SPDR Gold Shares ETF in our Virtual Portfolio. This is on the heels of us booking a near 2% gain (vs. our Dec 14th cost basis) in the security last week.
The bull case for gold is both well-known and well-understood, as there are a great number of investors – both institutional and retail alike – who religiously believe in and consistently preach the fundamental thesis behind owning the shiny rock that is gold.
Price, however, is set at the margin – not at the absolute levels of supply and demand. To the marginal buyer or seller of this asset, the case for gold as a haven away from world reserve currency debauchery is becoming less supportive. In short, we’ve been saying that Bernake’s Box + Eurocrat Bazooka (or lack thereof in some respects) = a King Dollar breakout.
Statistically speaking, the underlying commodity itself carries an inverse correlation to the U.S. Dollar Index of r² = 0.92% on our immediate-term TRADE duration. Correlations are neither causal nor perpetual; that said, however, r-squareds in this area code do signal to us that a singular trade or set of fundamentals is driving the bulk of the price action. It is our task as risk managers to: a) have a view on the expected duration of that trade, and b) have an outlook for the slope(s) of those fundamentals.
While the long-term story behind owning gold is still very much intact (for now), our research and our multi-factor, multi-duration quantitative analysis suggested to us that the short term price outlook carries asymmetric risk to the downside. Throw in the behavioral aspect of continued investor liquidations into and through year-end and we have ourselves a short idea.
Where could we be wrong? Simple – Bernanke coming out of left field and doing more of what he’s spent his entire life learning to do and defending. As my colleague Kevin Kaiser summarizes in his recent Early Look note, economics itself is soft science that functions as an ideology for central bankers – very much akin to partisan belief system that is behind the gridlock we’ve come to expect out of Capitol Hill. We must never forget the ever-present risk that is ideology-based policy-making and the impact that has on our P&Ls.
In short, QE3 could make us very wrong on King Dollar and gold. Thankfully, we in this industry get paid a lot of money to do the work, Embrace Uncertainty, and make tough decisions every day so that our clients don’t have to.