Gold's Silver Lining

This note was originally published at 8am on November 04, 2013 for Hedgeye subscribers.

“The silver of Potosi helped to destroy Spain.”

-Jack Weatherford

I bought Gold for the first time in over a year on Friday. Gold’s perverse, but modern, silver lining is what it’s always been – an un-elected body of central planners (the US Federal Reserve) having the unlimited and un-checked power to interrupt this thing called gravity (also known as the economic cycle) via A) currency devaluation and B) rate repression.

Down Dollar, Down Rates = Gold Up. And the precise opposite of that has been occurring for the better part of a year now (so we were shorting Gold on all bounces because expectations of getting the Fed out of the way (tapering) was perpetuating the always progressive two-stroke engine of US #GrowthAccelerating: #StrongDollar + #Rates Rising.

 

Like the fall of the hoped-to-be “New Spanish World Empire” of the 16^th century, most government expectations tend to fall on Shakespeare’s sword of un-planned heartache. “Spain, the greatest beneficiary of the Potosi silver soon bankrupted itself. By 1700, Spain was reduced to a minor power of neither economic nor political importance.” (Indian Givers, pg 25)

Back to the Global Macro Grind…

“Potosi was the first city of capitalism, for it supplied the primary ingredient of capitalism – money.” –Jack Weatherford

You won’t read that every day. And you won’t see me take my asset allocation off of 0% to both Commodities and Fixed Income every day either:

1. COMMODITIES: 0% asset allocation for 165 days
2. FIXED INCOME: 0% asset allocation for 100 days

Many did and did not agree with my risk managed decision to not lose money in each of those major investing styles. That’s why there are many different YTD performance numbers for Global Macro hedge funds in 2013. Not losing money in Gold was a choice.

Today, drum roll, I’m going to get all wild and crazy and take up my asset allocations to COMMODITIES and FIXED to 6% each:

1. Cash = 34%
2. Foreign Currency = 26% (or 79% of my max to an asset class)
3. International Equities = 21% (2/3 of my max)
4. US Equities = 6% (21% of my max)
5. Commodities = 6% (21% of my max)
6. Fixed Income = 6% (21% of my max)

“Of my max” means % of the max allocation I’d ever make to any asset class as a % of my total capital (which is 33%)

Why 33%? Why 60/40 equity/fixed %’s? Why have a rules based system that locks you into losing money for the sake of being “diversified” in a nice little pie chart that got blasted in June of 2013 when Gold and Fixed Income allocations were going haywire?

My Mom taught me to think for myself. My Dad taught me to not eat yellow snow. And when I wrote my senior thesis at Yale about Buffett, he taught me Rule #1 about investing – “don’t lose money.”

Despite all my faults as an investor, that’s the one thing I have somehow figured out since going to the buy-side at a hedge fund at the end of the internet bubble in the year 2000  - don’t lose money.

The other thing we’re better than bad at here @Hedgeye is risk managing the direction of the US Dollar (35 for 39 all-time on long/short USD position timestamps = +89.7% batting avg). And to get Gold right, you need to get the US Dollar right.

Currently, on our immediate-term TRADE duration, the US Dollar has an inverse correlation to Gold of -0.78. In other words:

1. If US Dollar Index fails at intermediate-term TREND resistance of $80.98
2. And Gold can hang in here and make another higher-low of 2013

Then I think I’ll have made the right move from an immediate-term TRADE perspective.

Another lesson I have learned the hard way in this business is to keep a TRADE a trade. That said, all great investments start somewhere and buying Gold on the first signal is what it is. For being long Gold to be an investment TREND, I need two things:

1. Gold to breakout of this bombed out base > $1342/oz (it’s still crashing at -22.1% YTD)
2. US 10yr Bond Yield to remain below this newly established TREND line of 2.63% resistance

I still think the odds of Bernanke and Yellen having my back on this at the December meeting are high (no tapering). Therefore I think the odds of this mini-cycle high of 2.5% US GDP being an intermediate-term top are heightening as well.

Again, to review what our GIP (Growth, Inflation, Policy) model is currently signaling:

1. #StrongDollar + #RatesRising = US GDP accelerating to 2.5-3%
2. Devalued Dollar + #RatesFalling = US GDP #GrowthSlowing back to 2%, then 1-1.5%

So, if you want the USA to become like Spain in 1700, beg for more Bernanke, Down Dollar, and Rate Repression. It’s a really cool and coy thing to do, provided that you don’t explain it to anyone that this is really why you want to be long Gold’s Silver Lining.

Our immediate-term Risk Ranges are now as follows:

UST 10yr Yield 2.55-2.63%

SPX 1755-1771

USD 80.13-80.98

Euro 1.34-1.36

Pound 1.58-1.60

Gold 1311-1341

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer